Helen Marsh and Elizabeth Small outline how the complex tax landscape has shifted to make corporate ownership of residential property more popular again.
The tax landscape for corporate bodies holding residential property has changed beyond all recognition in the past six years. The annual tax on enveloped dwellings (ATED), ATED-related capital gains tax (CGT) and the 15% stamp duty land tax (SDLT) flat rate charge on what used to be called “mansions” (those costing £500,000 or more, which soon included modest properties in London) caused a rush to de-envelope properties that were used as homes rather than qualifying investments, on which relief from these three tax charges could be claimed. Further changes to inheritance tax meant that the time-honoured approach of a non-UK domiciled person holding their UK property through an offshore company to mitigate exposure seemingly no longer worked; there was no good reason left to hold any residential property (including investment property) in a company.
Times change
Individuals buying an investment property now pay 15% SDLT on any of their purchase price above £1.5m (under the higher additional rate dwelling (HARD) 3% surcharge regime), so a 15% flat rate charge for corporate ownership no longer seems penal. Individual ownership to avoid ATED CGT is no longer relevant, as non-resident individuals will be subject to non-resident CGT (NRCGT) on the growth in value of their investment property.
Slowly we are seeing the resurgence of corporate ownership. An obvious advantage is limited liability. Further, a non-resident individual investing via a non-resident special purpose vehicle (SPV) should benefit from privacy, as neither the beneficial ownership of the property nor of the offshore SPV has to be disclosed on any publicly accessible registers. Offshore SPVs often enjoy quite flexible company law regimes, which can be useful if the ownership of the property is to be shared among, say, family members. Shared ownership via a vehicle is often easier than through a declaration of trust.
The costs involved
Of course, these advantages will mean increased expense. Professional fees on the purchase will be higher with ongoing administration and compliance burdens. This includes the necessity to file ATED returns even where business relief is available. HMRC actively polices this regime to ensure that the claim for exemption from the flat rate 15% SDLT charge and ATED is valid.
Any investor must make sure that they let out their property as soon as practicable after completion of their purchase or that they have valid reasons for not doing so (ie extensive works to the property), a proper paper trail showing a business plan and the steps and timeframe within which this will be realised.
Financing is a critical cost and sometimes it may be more difficult or expensive for a company to borrow than for an individual. Interest rates are historically low, but nevertheless claiming an interest deduction when calculating taxable income is an important consideration when structuring a purchase. A 2017 measure has swung the pendulum back in favour of a company. Before 2017 all taxpayers were able to claim a tax deduction at their marginal tax rate for the interest they paid, but since 2017 a restriction has been phased in over four years with the aim to give only basic rate tax relief from April 2020. There will be a significant increase in the tax bill for higher and additional rate taxpayers from 2020.
Limited companies are not subject to this new mortgage interest relief restriction. However, companies paying interest offshore need to be mindful of withholding tax, which can dramatically increase the cost of borrowings if the borrower has to gross-up the interest payment for UK 20% withholding tax; but an offshore SPV rather than a UK SPV gives greater room for arguing that withholding tax is not applicable.
Know your rates
A detailed cash flow analysis should always be undertaken as there are different tax rates. Currently companies pay corporation tax at a fixed rate irrespective of size: 19%, reducing to 17% from April 2020. This compares very favourably with 40% (the higher rate) and 45% for additional rate taxpayers.
Company ownership always means two potential layers of taxation: first at the level of the SPV and second for the individual when cash is distributed from the company to the individual. A non-resident individual will need to consider their tax position carefully.
Furthermore non-resident companies will be subject to corporation tax on capital gains in respect of the growth in value of the property that it holds and will not be able to benefit from the annual allowance of £11,700. Tax on the extraction of those profits will have to be considered carefully.
A SPV is thus pregnant with a latent tax charge but a seller may not bear all (any) of that charge if he sells the shares in the offshore SPV to the buyer. The buyer saves SDLT of rates up to 15%. Typically there is a deal to be struck between the SDLT saving and the latent corporation tax liability.
A balancing exercise
Company ownership gives flexibility because the property itself can be sold, or the shares in the immediate SPV or in a holding company of that vehicle. Those who did not rush to de-envelope and who could claim relief from ATED CGT were in a happy position because, when NRCGT was first introduced, it did not apply to indirect disposals; there was no tax charge for a non-resident when he disposed of shares in the SPV.
However, from April 2019, a shareholder who has a substantial indirect interest in UK land (broadly 25% or higher) in a property-rich entity (ie derives at least 75% of its value from UK land) will be subject to CGT on the disposal of shares in the SPV. It is immediately apparent that minority property holders may well prefer indirect ownership.
No one size fits all and every potential purchaser should get expert tax and legal advice on their particular facts and circumstances. But there is life in the old company yet.
Main image © Andy Rain/EPA-EFE/Rex/Shutterstock
Helen Marsh and Elizabeth Small are partners at Forsters LLP
