UK: Profits From Trading In And Developing UK Land and Property: March 2016 Budget Introduces Measures Targeting Tax Treaty Planning

Summary

Many of the UK's double tax treaties have allowed profits deriving from UK land and property development and dealing activities to escape UK tax where a non-resident developer undertakes a property trade with treaty protection and without the creation of a permanent establishment ("PE") in the UK.

The Budget statement includes the announcement of measures to ensure that all profits arising from trading, developing or dealing in UK land and property will be within scope of UK tax, irrespective of the absence of a UK PE.

The UK's treaties with its own dependencies of Jersey, Guernsey and the Isle of Man are particular targets, with the Government announcing that protocols to those treaties have already been agreed and will shortly take effect.

There is also a Targeted Anti-Avoidance Rule (TAAR) taking effect immediately, the aim of which is both to prevent attempts to escape the proposed legislation before it takes effect and to counteract attempts to circumvent the new legislation in the future.

The planning targeted by the new measures

Whether the property is held for trading or investment purposes determines the tax treatment of the profits.

Investment activity: Profits deriving from investment activities are taxed in the nature of gains. This includes profits on the sale of property held for a rental business, since the profits on disposal represent the proceeds of a longer term investment.

Following the introduction of Non-Resident Capital Gains Tax ("NRCGT") with effect from April 2015, all UK residential property held for investment purposes is now within the scope of UK capital gains tax - irrespective of whom it is held by (UK resident or non-resident).

However, a non-resident seller of commercial property held for investment purposes has remained outside the scope of UK tax.

Investment activities are not generally targeted by the proposed changes.

Trading activity: Property purchased for the purposes of development, refurbishment or a property dealing trade is held as trading stock and, therefore, the profits arising on disposal are taxed in the nature of income. Non-resident companies are subject to UK tax in one of the following alternative ways in respect of UK-sourced trading profits:

(a) If there is a UK PE, to corporation tax at 20%; or

(b) If there is no UK PE and no double tax treaty protection, to income tax at 20%; or

(c) If there is tax treaty protection and no UK PE, the profits were (until now) beyond the scope of UK tax.

It is profits falling within category (c) that are the target of new legislation.

The tax treaties in question

Several of the UK's treaties afford protection to UK source trading profits for residents of the treaty-partner countries providing no UK PE exists. These include the treaties with the UK's own dependencies of Jersey, Guernsey and the Isle of Man; which have been amended by protocol with effect from Budget day – 16 March 2016. The protocols include provisions to catch transactions where shares in a company holding UK property are sold instead of the property itself.

The proposed changes to UK law (which will be the subject of a brief consultation) will effectively override the protection afforded by all other treaties. The UK tax authority claims that these treaties are not in line with the OECD model standard, which preserves taxing rights for the country in which immovable property is situated.

Conclusion

The UK property market (especially residential property) has experienced an extremely lengthy boom period in the face of a general shortage of supply and also rising demand (especially from foreign investors), which has made it increasingly difficult for first-time buyers to purchase a home. Several legislative initiatives seek to cool the UK property market (including the ATED tax on private homes held by companies, NRCGT, extra 3% stamp duty on second home purchases and limiting the deductibility of mortgage interest for landlords).

As the rate of UK corporation tax reduces to 17% by 2020, we expect to see increasing interest in the use of UK companies for UK real estate activities.

The growth in tax legislation affecting UK property means it is increasingly important that professional advice is sought before transactions are undertaken.

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.