With changes to capital gains tax for non-resident investors just a year away, Nick Burt and Emma Tuppen share their tips for how to prepare
It has now been over four months since the unscheduled budget announcement that non-residents will become subject to UK tax on capital gains (CGT) on direct and indirect disposals of UK real estate. The government’s consultation has been closed, industry representations have been made and, by and large, the mood seems to be one of acceptance. Although, of course, the full economic impact of the changes is not yet known.
Here is a reminder of some of the basics of the proposed changes and what we might expect to see later this year.
Non-resident investors: journey to CGT
UK residents are within the scope of CGT on disposals of UK real estate. Until recently, unless the land was held by a UK permanent establishment carrying on a trade, or certain anti-avoidance rules applied, non-UK residents were not taxed in the UK on any such disposals.
2013 saw the introduction of “ATED-related CGT” payable by companies and collective investment schemes holding high-value residential property (subject to certain exceptions). In 2015, a charge to CGT was brought in for all non-residents holding residential property unless such non-residents were diversely owned or widely marketed.
Finally, in a bid to bring the UK into line with other major economies, the government announced at the autumn budget in November 2017 that from April 2019, disposals of commercial property held by non-residents would come within the scope of CGT, and the exemption for diversely held/widely marketed entities holding residential property would be removed. While the principle of such a charge is not up for debate, the detail was subject to consultation (Taxing gains made by non-residents on UK immovable property – consultation).
Direct disposals
As the name suggests, a direct disposal of real estate is a disposal by a non-resident. Only gains arising after 1 April 2019 (for companies) or 6 April 2019 (for individuals or trustees) will be chargeable to CGT. This is to be achieved by way of a rebasing of property values for tax purposes as at those dates.
If the non-resident has made a loss overall, but a gain would accrue under rebasing, then there will be a computational option of using acquisition cost.
No specific valuation requirements are expected but taxpayers should consider what evidence is appropriate to support their views as to value.
Investors who benefit from an exemption from CGT (other than as a result of residence), such as sovereign wealth funds, overseas pension schemes or offshore companies within a UK REIT group, will continue to benefit from such exemption.
Indirect disposals
A CGT charge will apply to gains from sales of a “property-rich SPV”. An SPV is property-rich where it directly or indirectly derives 75% or more of its value from UK land. Typically, this will apply in the context of real estate owned by a company or unit trust, where the disposal is of the shares or units. All the gain is intended to be subject to tax, not just the part referable to the UK land.
Without a charge on indirect sales, it would be possible to defer tax on gains by selling the vehicle that owns the real estate. However, to prevent smaller investors falling within scope, there is a 25% threshold requirement.
The 25% threshold is subject to aggregation rules. It is proposed to include connected parties, as well as persons “acting together”. To prevent avoidance, past holdings in the last five years are taken into account for the purposes of assessing whether the threshold is met.
Unlike the position for direct disposals, rebasing will only be by reference to market value in April 2019.
However, as with direct disposals, investors who are otherwise exempt will continue to benefit from those exemptions on a sale of the property-rich SPV. In addition, the substantial shareholdings exemption (which exempts companies from CGT on gains from sales of shares) may be applicable in certain limited circumstances.
What will happen next?
The consultation closed on 16 February 2018, and draft legislation is expected in the late summer. Responses have been submitted by a variety of interested parties (including ourselves). The issues raised have been numerous, with some key points as below.
■ Timing
There had been some pressure on the government to delay the implementation date to April 2020. Non-resident landlords are to be brought within the charge to corporation tax on their rental income on that date (the simpler income tax regime currently applies). So there is some undeniable logic to introducing both changes at the same time.
In addition, deferral for a year would put some distance between the introduction of the charge and the challenges and uncertainties brought about by Brexit.
Finally, it would give both the government and the market more time to consider and iron out any problems or unintended consequences of the proposed changes. At the date of writing, the charge is however expected to apply from 2019 as announced.
■ Collective investment schemes
It is hoped that the government will address how the charge will apply to collective investment schemes. The proposed rules are particularly disadvantageous for exempt investors who choose to pool their funds, unless the pooling vehicle is transparent for tax purposes (such as a partnership) or itself tax exempt (which is only applicable in very limited circumstances).
Take, for example, a sovereign wealth fund and an overseas pension fund investing in UK real estate through a Jersey unit trust (JUT). Both investors benefit from a CGT exemption. If the JUT sold the property after April 2019, it would be subject to CGT on any gain. If the investors sold their units, although they would not be subject to tax, a buyer would most likely request a price chip for the latent CGT in the JUT. In both cases, the exempt investors effectively suffer at least some of the CGT costs.
While the JUT currently has clear tax advantages (transparent for income tax, outside the scope of CGT and its units are wake
not subject to any stamp taxes), many of the representations also highlight its non-tax benefits (eg it is lightly regulated) and the fact that the UK does not offer a comparable vehicle. While REITs, PAIFs and COACs offer similar tax benefits, and may offer a solution to some investors, they are highly regulated and/or demand liquidity, which may not be appropriate in the non-retail market.
In the absence of any new UK vehicle being created (the relatively short timeframe for implementation is likely to prevent this), the industry is hopeful that the government will look to exempting diversely held funds or funds with a qualifying exempt investor base.
■ Threshold for indirect disposals
Also in the context of collective investment, the 25% threshold under which investors will not be chargeable needs further consideration. While a threshold is applauded, the effect of the look-back period and the aggregation with interests of connected persons, could distort results. For instance:
■ connected persons might have sold, leaving an investor with less than 25%, but remaining within charge because of the proposed look-back charge;
■ a seed investor or a last man standing would be prejudiced by such temporary status; and
■ the acting together rules are very unclear and could potentially include investors with a common purpose dictated by a common fund manager.
■ Relief for onshoring
Appreciating the inevitability of the charge, investors may consider bringing their holding onshore. The government has therefore been asked to consider a relief from any tax on such restructuring, with stamp duty land tax (SDLT) being the obvious concern. To date there has been no indication of whether the government would agree to this.
What to do next
In the absence of any draft legislation, it is not advisable to seek to restructure existing holdings. The changes should however be taken into account when considering the best vehicle and holding structure for new acquisitions.
Even on the date, and in the immediate wake, of the change, restructuring may not be the best option. Because of the rebasing, there may still be a benefit of retaining assets within a vehicle because of any potential SDLT saving on sale.
What is clear is that the detail of the rules will need careful consideration, and for many investors there are likely to be costs associated with valuations, possible restructurings and the consequent compliance burden.
Nick Burt is a partner and Emma Tuppen is a senior associate at CMS Cameron McKenna Nabarro Olswang LLP
