UK Tax considerations when investing in UK real estate
At the start of the last decade, the UK tax regime for offshore investors in UK real estate was fairly straightforward.
In recent years the tax position has become much more complex.
In this article, we outline the main UK tax considerations in the life cycle of a long-term investment into UK commercial property by an offshore investor who does not benefit from any specific tax exemption. Additional tax issues will arise for investments which are short term in nature, or which involve residential property, or developments works, or if they are made through collective investment schemes, or if they have any tax exempt investors (for example, sovereign wealth funds).
As with any tax analysis, the devil is in the detail but we have set out some of the main tax considerations below which need to be balanced with the commercial objectives and practical operational costs.
The main issue to decide on acquisition is whether to acquire the property itself or the entity which owns the property. If the entity is a special purpose vehicle which was incorporated with the sole purpose of owning the target property (an SPV) then it may be possible to acquire the SPV. It may not be possible if, for example, the entity holds other assets. This will determine the amount of upfront tax costs, such as stamp duty land tax (SDLT) and value added tax (VAT) which is not recoverable; affect cashflow in the case of recoverable VAT and also impact on the financing arrangements.
If the property is acquired, SDLT will be payable by the buyer on the purchase price (including any VAT) where the property is situated in England or Northern Ireland (there are similar but not identical land taxes in Scotland and Wales). SDLT on non-residential property is paid in slices. It starts at 2% on the purchase price over £150,000 and increases to 5% on the purchase price which exceeds £250,000.
In comparison, SDLT does not generally apply to the acquisition of a SPV holding real estate (unless it is a partnership). Purchasing the SPV rather than the property itself can therefore produce a significant SDLT saving for a buyer. As a result, the seller can sometimes demand a higher price for the sale of an SPV, effectively sharing the SDLT saving between the parties.
Whilst the UK operates stamp duty (at 0.5%) on the purchase of company shares, we would not expect UK stamp duty to be payable on the acquisition of shares in an offshore SPV.
There are other commercial and tax risks involved in buying an SPV rather than acquiring the property. Appropriate due diligence should always be carried out to identify these risks and ascertain whether they outweigh the SDLT saving. In particular, the buyer should understand the base cost of the property since this will determine the amount of gain subject to UK tax when, and if, the property is sold by the SPV in the future.
A potential investor should also review the capital allowances (CAs) position and consider whether these will be available following the purchase. CAs are a form of tax deductible depreciation for certain fixtures within the property and can represent a valuable tax asset for a buyer. CAs are often mentioned in the agent's marketing materials and the availability of CAs should be raised at the heads of terms stage. Proper structuring (including the filing of appropriate elections with HMRC) can increase the availability of CAs on an acquisition of the property.
The acquisition of a property may be subject to VAT at 20%. If so, this will be charged on top of the agreed price. Whether VAT is to be charged will depend upon the nature of the property being purchased and whether it has been opted to tax by the seller. A properly advised buyer will generally be able to recover VAT it incurs from HMRC (although there will be VAT registration and compliance to deal with). However, paying VAT on the purchase will produce a cashflow cost prior to the VAT being recovered from HMRC and will also increase the SDLT cost for the buyer (effectively an extra 1% of SDLT on the purchase price). The buyer should therefore explore whether the purchase can be classified as the transfer of a going concern (for example, where the property is acquired with the benefit of an existing lease) in which case no VAT would be payable.
In comparison, the acquisition of a SPV will not be subject to UK VAT.
Operation – renting a property
The rent from a UK property held by a company (whether onshore or offshore) will, from 6 April 2020 be subject to corporation tax. Previously offshore companies were subject to income tax on their UK rental income.
The UK operates a withholding tax regime under which tenants or agents have to deduct tax from payments of rent to offshore landlords. Fortunately it is relatively straightforward for landlords to receive approval from HMRC to receive the rent without the deduction of tax. Landlords will have to self-assess their tax liability and pay tax to HMRC for the relevant accounting period but receiving the rent with tax being deducted upfront significantly improves the landlord's cashflow.
Non-resident individuals who hold UK property directly (or through tax transparent structures such as a partnership or a unit trust) will be subject to income tax at a rate of up to 45%, depending on the amount of taxable rental income. In comparison, corporate landlords are subject to corporation tax (at 19%) on their rental profits.
Prior to 6 April 2020, the UK rental profits of an offshore company were subject to income tax (at 20%). Whilst the corporation tax regime currently has a lower rate of tax, there are different rules for calculating the level of taxable rental profit and determining when such tax is payable. In summary, these are:
- The loan relationship rules which determine the deductibility of interest and other finance costs.
- The corporate interest restriction rules which need to be considered where the UK interest and finance expenses, on a consolidated group basis, exceed £2 million a year. These rules are complex but generally speaking they can potentially operate to restrict interest deductions to 30% of EBITDA.
- The anti-hybrid rules, which are designed to counteract tax advantages for hybrid arrangements or entities (such as where a cross-border payment is treated differently for tax purposes by the different jurisdictions involved).
- The loss restrictions rules where the use of brought forward income and capital losses will be subject to restrictions after April 2020.
- The payment date rules which can be more frequent than under income tax.
Tax on exit
Until recently, disposals of UK commercial property by non-UK resident investors were not subject to UK tax, giving non-UK investors a significant advantage over UK tax-resident investors. With effect from April 2019, the tax position has been aligned, so that gains on direct and indirect disposals of UK real estate (i.e. including disposals of shares or units in entities that derive value from UK real estate) are within the scope of UK tax. This was already the case in most other jurisdictions.
The rates of tax on such gains are the same whether the investor is UK resident or non-resident, being 19% for corporates and a top rate of 20% for individuals. Where an offshore investor held the property prior to April 2019, the taxable gain on a disposal of the property will be calculated by reference to the market value of that property on 5 April 2019. Similarly, if shares or units in an SPV are sold then the taxable gain will be calculated by reference to their market value at 5 April 2019. There are alternative methods which can be used to calculate the gain so that, for example, investors can elect to use the original cost rather than the April 2019 value when computing the gain.
There are some situations where non-resident investors making indirect disposals might not be taxed. For example, there is an exemption for the sale of an SPV which holds a property which is used in a trade (provided that trade is operated by that SPV or another group company). This could help investors in property rich businesses such as hotels and care homes which often operate using an "Opco-Propco" structure. Alternatively, it may be that some minority investors are outside the scope of tax entirely, although it may be difficult to achieve this in practice, or that they can claim protection under a Double Tax Treaty.
Which jurisdiction – offshore or onshore?
As a result of the various changes to the UK tax regime, on the face of it, a lot less turns on whether to use a UK company or an offshore company in the scenario we have been considering.
Using an offshore company in a nil/low tax jurisdiction is likely to provide some tax advantages in most cases and should not leave the investor in a worse position. For example, on an exit, a future buyer may prefer an offshore company rather than a UK company because of the potential stamp duty saving or because an offshore company suits the future buyer’s tax position.
In addition, an offshore company may also result in a reduction in VAT cashflow costs and the withholding tax analysis on interest payments may also be improved. Where the investor is an individual, and provided it is structured correctly, an offshore company could be used to prevent an exposure to UK inheritance tax on the shareholding.
The scope of UK tax and reporting obligations that are applicable to offshore investment into UK real estate is now broader and more onerous than ever before and this note only highlights some of the issues which need to be considered. With specialist tax advice on investment structures, identifying tax risks and available tax reliefs, and balancing them with the commercial and operational considerations, we can and do help investors make the most of their UK real estate investment.
Please do get in touch to discuss how we can help.