UK: Property Bulletin - Summer 2011

FOLLOWING THE BUDGET, THERE IS GOOD NEWS AND BAD NEWS FOR THE PROPERTY INDUSTRY.

By Sarah Hartill

Good news stories in the Budget included the disaggregation of stamp duty on bulk house purchasing and potential changes to the UK REIT regime – which are covered in more detail later in the bulletin.

Stamp duty land tax

The bulk purchase rule means that the rate of stamp duty land tax (SDLT) may by election be determined by the average value of each of the dwellings acquired, rather than the total transaction value. This is subject to a minimum rate of 1%.

This means that the stamp duty burden for multiple unit investors will be more aligned to that of individual unit investors on the purchase of residential properties. It is hoped this will encourage more institutional funds into residential property investment. This measure will apply for transactions where the effective date is on or after the date on which the 2011 Finance Bill receives Royal Assent.

Entrepreneurs' relief

The doubling of the entrepreneurs' relief life time allowance to £10m will benefit owners of property development and trading businesses. For individuals that qualify for the full allowance this relief now represents a saving in capital gains tax (CGT) of £1.8m against a benefit of just £80,000 when this relief was first introduced. This applies to disposals from 6 April 2011.

Capital allowances

On a less positive note, the Government proposes to introduce a fixed timeframe within which the purchaser of a building must pool their expenditure on fixtures in order to qualify for capital allowances. Furthermore, it is proposed that the purchaser must agree with the seller the amount of the sale price attributable to the fixtures, which must then be notified to HMRC.

This targets claims which are made several years after the acquisition, when a lack of information in relation to claims made by the previous owner could result in duplication of allowances. However, this will also impact taxpayers who have genuine commercial reasons for deferring a claim; for example if the availability of tax losses means the cost of a contemporaneous analysis of fixtures would not be of immediate value.

Those worst affected if these proposals go ahead will arguably be the purchasers of commercial buildings and the specialist capital allowances advisers who have been successful in assisting them to make substantial 'late' claims on second-hand fixtures. These proposals are subject to consultation at the moment and the relevant legislation is scheduled to be included within the Finance Bill 2012.

Another disappointment has been the removal of a useful concession to the basic rule that, if plant or machinery is partly used for a dwelling house and partly in communal areas, then there must be reasonable apportionment between the two.

The de minimis that was previously included in HMRC's guidance manuals meant that if the amount of expenditure that would not qualify for allowances was 25% or less of the total, then allowances were given on the whole amount. Capital expenditure incurred on or after 22 October 2010 must be analysed for its benefit to both communal and dwelling areas, even when the proportion relating to the dwelling is small.

DIRECT PROPERTY OWNERSHIP OR OWNERSHIP THROUGH AN OFFSHORE COMPANY? WE DISCUSS THE TAX CONSIDERATIONS FOR NON-RESIDENTS ACQUIRING UK PROPERTY.

By Rajesh Sharma

The nation's obsession with bricks and mortar has been well documented and seems unlikely to alter anytime soon.

However, obsession does not stop at the UK border and prime property transactions are being driven by non- UK resident individuals. Whether other factors are at play, currency hedges, perceived domestic risk/instability in the non-resident's own country can be argued about, but certainly non-residents are active in the market.

Acquiring UK property

Those with sophisticated knowledge will have heard of, and may well understand, Sharia mortgages, SDLT mitigation, special purpose vehicle planning etc. All of these elements can have a bearing on how purchases are structured, but in essence the choice an overseas investor can make is actually between direct property ownership and ownership through an offshore company.

Direct property ownership

Where investors have cleared funds, with no need for debt to make acquisitions, individuals have acquired UK residential property directly. This normally occurs where the transaction is investment in nature, and where the individual is in a low tax jurisdiction with a settled pattern of residence there.

For the non-UK investor income tax is not payable in the UK, unless income arises from the letting of the property.

If the property is used for letting, the individual usually registers as a non-resident landlord (NRL) and receives rental payments gross. The effect is to stop deduction of tax on rents at source, leaving the individual to file tax returns at the normal tax return dates and pay tax at the normal tax payment dates – a far better position for cash flow and planning purposes.

UK CGT is only chargeable on UK resident or ordinarily resident individuals. So, provided non-UK residence is maintained, CGT (in the UK) is not payable. However UK IHT is payable on assets which are sited in the UK at the time of death. This means that property owned directly would be potentially liable to IHT, whereas shares in an offshore company would not be.

Ownership through an offshore company

If direct ownership is so straightforward, then why opt for ownership through an offshore company? Broadly, if the property value is large, if UK SDLT is significant, and where direct ownership means exposure to IHT, then the use of a nonresident company can be more favourable. If income is derived from the letting of the property the overseas company will usually register as a NRL, again enabling rents to be received gross.

However, there are some pitfalls to be aware of. For example, if offshore structures are not operated correctly, a non-UK resident company that is not incorporated in the UK becomes subject to UK corporation tax when it carries on business in the UK. Care is required to maintain a non-UK resident profile – the company must not be managed and controlled in the UK. Failure to achieve this would expose any gain on the disposal of the property by the company to UK corporation tax.

There is a need to monitor the tax status of the jurisdiction of the overseas company as tax regimes change. In fact they move rapidly. Care is required when acquiring property in a company resident overseas. A watching brief will be required with reference to the tax position for the company and that on the extraction of funds from the company to the jurisdiction where the shareholder is resident.

Property development

The position is different for property development. Where this occurs the development is likely to be regarded as a permanent establishment and therefore a trade subject to income tax in the UK (when held personally) and corporation tax (when held via a company).

In addition, the range of taxes will need to be considered including VAT and inheritance tax, as well as anti-avoidance rules where investment or development occurs.

Conclusion

There is no single route for property ownership, but the basics are straightforward. Usually there are valid reasons for complexity, but if you are unsure about a structure, whether advising or investing, you should speak with your adviser. Tax is rarely the driver for these investments, but it is often the biggest ongoing cost and it is surprisingly easy to trip up.

NAMA WAS CREATED ON 21 DECEMBER 2009 FOLLOWING THE GLOBAL FINANCIAL CRISIS, AS PART OF A SOLUTION TO STABILISE THE IRISH CREDIT INSTITUTIONS, PROTECT THE STATE'S INTERESTS, CREATE LIQUIDITY AND RESTORE CONFIDENCE IN THE IRISH BANKING SECTOR.

By Henry Shinners

The numbers

To achieve its aims NAMA (National Asset Management Agency) has acquired €81bn of loans and associated assets from the participating institutions at a discount, and manages those assets for the benefit of the Irish taxpayer over a seven to ten year lifetime.

There were widespread concerns that NAMA would pay too high a price for the assets it acquires, resulting potentially in a huge loss to the Irish taxpayer, but its objective is to break even as quickly as possible.

The participating institutions and the loans to be acquired from each are as follows.

NAMA funds the acquisition of loans in the form of government-backed securities, which the participating institutions can use to create liquidity through repo activities with the European Central Bank and the market. The discount applied to the nominal value of the acquired loans varies between the institutions and across asset types, with an average discount of circa 58% having been applied to the €72bn of loans acquired to date.

36% of the loans acquired by NAMA in the first two tranches related to assets based in Britain and the Channel Islands.

The NAMA operation

Transparency and confidentiality

In its short existence, NAMA has developed a great reputation for secrecy but it has to function within the confines of the legal framework under which it operates. For example, the way in which it has conducted the tender processes for each of its panels of professional advisers (including lawyers, valuers, enforcement and insolvency professionals) has been open and details of the appointments to each panel are available on the NAMA website (www.nama.ie). I am pleased to be able to say that Smith & Williamson have been admitted to the following panels:

• advisory work in connection with the review and evaluation of borrowers' business plans, and
• enforcement and insolvency services.

Dealing with debtors and assets

In relation to its dealing with debtors, the processes used are also quite well publicised. Debtors are required to produce a realistic business plan that recognises the scale of the problems and demonstrates that they are willing and can to do what is necessary to work their way out of difficulty.

If, however, debtors are unwilling to engage with NAMA, cannot do what is necessary to navigate a way through the difficulties or are unable to demonstrate long-term viability, NAMA has shown that it is prepared to take enforcement action. At 19 May 2011, NAMA had taken or approved enforcement action in 57 cases.

Where the reputation for secrecy primarily arises is, I think, in relation to the statutory requirement for NAMA and its officers to keep information relating to debtors (and associated assets) confidential. In reality, although this requirement is enshrined in statute, it is no less than each of us would expect from our own bank – that our affairs be kept confidential. Further, it would place NAMA at a commercial disadvantage and contradict its duty to obtain the best achievable financial outcome for the Irish taxpayer if it were to disclose, for instance, the amount it had paid for a debtor's loans.

To an extent, of course, these confidentiality restrictions do not apply to assets that are controlled by insolvency practitioners appointed by NAMA and in the near future the website will helpfully include a database of such assets.

Asset disposal strategies

NAMA's board has set targets for cumulative debt reduction over its expected life as follows.

With €77bn of debt at nominal value to be paid down by 2018, there seems little room for prevarication.

In keynote speeches given by NAMA Chairman Frank Daly and CEO Brendan McDonagh last month, we learned of the NAMA board's thoughts on strategy for maximising realisations in relation to commercial and residential assets.

They said that NAMA neither forces its debtors to "engage in a precipitative fire sale of assets" but nor does it "sit around in the hope that some fine day the current market hangover will cure itself", rather they seek a balance between these approaches. NAMA recognises itself as a significant player in the property market and acknowledges the responsibility it has to help lift the market out of its current stagnancy. It has approved the sale of circa €3.3bn in property assets since 1 March 2010, much of it in the UK.

Market drivers – supply, demand and liquidity

Naturally, in the context of the size of its property portfolio, NAMA does not consider that supply is going to be a problem for the market in Ireland in the short to medium term.

NAMA acknowledges however that purchasers need comfort that prices are at, or close to, bottom. For commercial property, it points to the long-term relationship between commercial property prices and economic growth and argues that prices have now been corrected (at 60% below their peak) to levels where they could have expected to have been had the bubble not occurred. We are told that NAMA has experienced considerable interest from (mainly foreign) investors in purchasing Irish commercial property.

NAMA admits that the outlook is less clear on the residential side, but maintains that it has received a substantial volume of enquiries from prospective individual buyers.

Regarding the key question of liquidity, NAMA has identified two initiatives through which prospective purchasers could have greater access to debt finance.

On the commercial property front, NAMA will consider making stapled debt available to the right purchaser, at suggested loan to value ratios of 70% to 75%.

Intriguingly, it has been announced that NAMA have held discussions with Allied Irish Banks and Bank of Ireland with a view to unveiling a product later this year that would provide some protection to purchasers against the risk of negative equity on residential property assets acquired out of the NAMA portfolio.

Unfortunately, given the restraints on credit that persist on this side of the Irish Sea, it seems unlikely that NAMA will extend these initiatives to purchasers of assets in the UK.

THE CHANCELLOR IS LOOKING TO IMPROVE THE WAY IN WHICH THE REIT SYSTEM OPERATES.

By Mark Webb

When REITs were introduced they were seen as a means of improving investment in and management of UK commercial and residential property.

However, the combination of their complexity, the conversion charge, the downturn in the property market and the different market dynamics of commercial and residential property has meant that adoption of the REIT regime in the UK has generally been restricted to the conversion of previously listed commercial property investment companies.

Further to the recommendations of the office of tax simplification, the Chancellor announced in the 2011 Budget that an informal consultation will take place with industry and representative bodies on how the rules for REITs can be simplified and relaxed to improve the way in which the system operates. In particular, the consultation will seek views on:

• abolishing the 2% conversion charge for companies joining the regime

• introducing a diverse ownership rule, meaning institutional investors such as pension and insurance funds wishing to establish REITs will be able to meet the non-close company rule that previously prevented them doing so.

In addition, the consultation will review the possibility of relaxing other rules, including:

• the requirement for a REIT to be listed on a recognised stock exchange
• improving the circumstances when cash can be considered an asset of the property rental business for determining whether the assets of that business are at least 75% of total group assets of the REIT
• extending the time limit during which stock divided distributions must be made.

These suggested changes may reignite wider interest in the REIT regime so that it meets the original intentions behind its introduction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.