UK: HMRC's Gain Is Non-Residents' Loss: Tax On UK Real Estate Gains For Non-UK Resident Corporates And Funds

Last Updated: 22 May 2019
Article by Dominic Lawrance and Helen Coward

Historic position

Before 6 April 2015, the UK was a notable outlier in the international community for having no regime for the taxation of gains realised by non-residents on a disposal of UK real estate (except in limited circumstances).

In 2015, the UK took the first step in changing this position by bringing disposals of UK residential property by non-UK residents into charge.  This legislation did not apply to widely held companies and widely marketed investment schemes, commercial property or disposals of property-rich entities (such as companies), and so investors in non-UK funds investing in UK real estate generally continued to fall outside the UK tax net in respect of gains.  Income realised by non-UK resident companies in respect of UK real estate is currently within the scope of UK income tax, but from 6 April 2020 will also come within the scope of corporation tax.

These gaps in the tax net have now been closed, by measures that extend UK taxation to all disposals of UK real estate by non-residents, including indirect disposals.  These new measures apply to disposals on or after 6 April 2019. 

This note focuses on the aspects of the new rules that will be most relevant to corporate taxpayers and institutional investors.  For a discussion of the rules focusing on the position of non-resident individuals and trustees, you can read about direct disposals of UK real estate here and indirect disposals here.

Direct disposals

The new rules mean that all direct disposals of non-residential UK real estate by non-UK residents are now chargeable to UK tax.

Direct disposals of UK residential property by individuals, trustees and closely held entities (e.g. companies controlled by fewer than 5 unconnected persons) on or after 6 April 2015 are chargeable to UK tax.  Disposals by widely held entities and widely marketed collective investment schemes (previously excepted from the scope of non-resident capital gains tax) are now also chargeable as a result of this measure.

Indirect disposals

Any disposal of interests in an entity on or after 6 April 2019 meeting the following two conditions is within the scope of UK capital gains tax (for individuals and trustees) or corporation tax (for other taxpayers):

  • the entity is "property-rich" (which will be the case if 75% or more of its gross asset value derives from UK real estate); and
  • the non-resident (taken together with connected persons) holds, or has at some point in the previous two years held, a "substantial indirect interest" in the land (broadly, at least a 25% interest in the entity). 

Determining value

An asset derives at least 75% of its value from UK land if: (1) the asset consists of a right or an interest in a company; and (2) at the time of disposal, 75% of the total market value of the company's "qualifying assets" derives from interests in UK land.

It is important to note that the reference to a "company" includes other entities that are treated as companies for this purpose (such as Jersey property unit trusts, JPUTs), but for ease of reference this note uses the term company.

Complex rules apply to determine a company's qualifying assets.  Generally speaking, UK land will always be a qualifying asset.  All other assets will also fall within the definition, save where matched to a related party liability (e.g. a loan receivable due from a group company).

The rules also allow tracing of market value through any number of entities or arrangements (including trusts), but not through a normal commercial loan.  "Normal commercial loan" takes the same meaning as in a group relief context, so broadly meaning loans without equity-like features such as results dependent interest.

"Linked" disposals

It is common to have property assets in separate companies to the main trading activities, both for non-tax purposes (e.g. liability ring-fencing) and for tax purposes.

In principle there is scope for a tax charge on the sale of a trading company and an associated sale of a property holding company, where tax might not be chargeable on the disposal if the business and the property were held by the same company (due to the 75% test referred to above).

However, there is a relieving measure where there are two or more disposals of interests in companies, which are "linked" to each other and where some of the disposals would be caught by the new indirect disposals charge.

In that case, the rules allow you to aggregate the assets of all of the companies being disposed of in applying the 75% test.

Disposals will usually be "linked" if made by the same person (or connected persons) to the same person (or connected persons) under the same arrangements.

Substantial indirect interest

The main rule is that a person has a substantial indirect interest in UK land if the person has a 25% investment at any time in the two years ending with the time of disposal.  That investment can be direct, indirect or a combination.

A person can have a 25% investment by virtue of any one of a number of criteria, including voting power, entitlement to proceeds on a sale, rights to income distributions and rights to capital proceeds on a winding up.  Normal commercial loans (i.e. non-equity like loans) and restricted preference shares (fixed rate preference shares with certain other features) are ignored but all other interests will be taken into account in applying this test.

Holdings by connected persons are aggregated in applying the test but contrary to the usual position under tax legislation siblings are not considered to be connected for this purpose.

Possible ways out of the charge for trading businesses

An exception from the charge on indirect disposals applies where it is reasonable to conclude that all of the company's interests in UK land are used for the purpose of a trade that has been carried on by the company or a person connected with it throughout the year prior to the date of disposal.

It must also be reasonable to conclude that the trade will continue to be carried on for more than an insignificant period of time in order to qualify, meaning that on disposals to third parties taxpayers should consider obtaining contractual protection that the trade will not immediately cease.

Where a company holds interests in UK land that are not used for trading purposes, the exception will still apply if those non-trading properties comprise no more than 10% of the total market value of the company's interests in UK land.

In addition to this exception, which was aimed at property-rich trading businesses such as supermarkets and hotels, the existing substantial shareholding exemption (SSE) may well be relevant to disposals of shares in trading companies.  It is broadly available on disposals of shares in trading companies or the holding companies of trading groups where the holding was at least 10% and has been held for a continuous 12 month period in the six years prior to disposal.  Where the disposal is made by an institutional investor, disposals of investment companies can also qualify.

In this context "trading" allows for up to 20% investment activity by reference to the company's balance sheet, income and management time.  This therefore allows a greater proportion of non-trading activity but is judged by reference to more factors.

Corporate compliance

Entities coming within the charge to corporation tax as a result of this measure (i.e. on a disposal of UK land on or after 6 April) must register for corporation tax within three months. 

Companies pay corporation tax and file corporation tax returns by reference to accounting periods.  Any company not already within the charge to corporation tax will come within the charge to corporation tax on disposal, giving rise to a one day accounting period.  This means that non-UK resident companies that simply hold a UK property (whether let or unlet) as an investment will have a one day accounting period each time it makes a disposal.  From 6 April 2020, non-UK resident companies with let UK property will come within the charge to corporation tax in respect of that income.

A corporation tax return is due twelve months after the end of an accounting period.  Payment of the tax is usually due nine months and 1 day after the end of the accounting period, but large or very profitable companies pay tax more quickly, by instalments.

Any company realising a chargeable gain in excess of £27,397 in a one day accounting period is potentially caught by these instalment payment rules and could be required to pay tax on the date of disposal.  By concession, HMRC will allow companies in this situation to pay within 3 months and 14 days after the end of the one day accounting period instead.

Impact on the funds industry

There has been widespread concern about the impact of the changes on the funds industry, which is a major contributor to the UK real estate market.  In particular, there was anxiety about:

  • the impact on exempt investors in offshore funds, which would suffer UK tax at the level of subsidiaries; and
  • potential for double taxation due to the multiple layers of vehicles commonly employed by funds in holding structures.

These issues were largely addressed during the consultation process.

Overview of the application of the rules to funds

The basic position under the legislation is that offshore collective investment vehicles (other than companies and partnerships) are deemed to be companies for the purposes of UK tax on chargeable gains, with the participants deemed to be shareholders.  This means that all such vehicles will be treated as opaque for the purpose of UK tax on chargeable gains.

Any person making a disposal with an "appropriate connection" to a collective investment vehicle (CIV) is deemed to have a substantial indirect interest in the entity.

Testing when a disposal has an "appropriate connection to a CIV" can be complex, but for example this will be the case on a disposal by a CIV, disposals of rights or interests in a CIV and disposals by partners in a partnership CIV.

This means that almost all disposals by, or of interests in, UK property-rich funds are caught by this measure regardless of the size of the interest that the investor has in the fund.

Where a fund is genuinely diversely owned (or for companies, widely held) and the prospectus does not envisage more than 40% of the expected market value of investments to derive from UK land (directly or indirectly), then the appropriate connection rule is switched off.  This will be useful for pan-European real estate funds which may inadvertently become UK property-rich.

The two main provisions that are intended to provide relief to real estate funds are as follows:

  • the fund can elect to be treated as transparent for the purposes of UK tax on chargeable gains; or
  • the fund can elect for special tax exemption, as long as certain conditions are satisfied.

Although the substantial indirect interest test is switched off, in order to be chargeable the entity must still be UK property-rich under the 75% test discussed above.

Tax transparency election

Offshore funds that are income tax transparent (such as JPUTs established as Baker trusts) will be eligible to elect for the fund to be treated as tax transparent for the purpose of UK tax on chargeable gains.

This has the effect that non-UK resident investors will be treated as owning a share of the properties (or property holding companies, as applicable) directly.  When such investors dispose of their interests in the fund, they will be taxed on the value of the property less the proportionate original acquisition value of the property.  This treatment is likely to be particularly useful for smaller, simpler fund structures with tax exempt investors.

This election will be irrevocable and unanimous investor consent must be sought at the time it is made.  There is a time limit for making this election: within 12 months of the fund first acquiring direct or indirect interests in UK land (or for funds already in existence at 6 April 2019, by 5 April 2020).

This election continues to have effect even if the investors change or the fund ceases to be UK property-rich.

Exemption election

The alternative, and possibly more attractive, solution is for the fund to elect to be exempt from tax.  This election can be made by an offshore CIV (specifically defined in the legislation and including a JPUT, for example) or by companies (including UK companies) at least 99% owned by a partnership or co-ownership authorised contractual scheme.

The election exempts direct and indirect disposals by the qualifying fund or company.  In addition, where the exempt fund or company has a 40% or greater investment in another entity then the appropriate portion of the gain accruing to that entity is also exempt.  For example, if an exempt company has a 50% interest in another company, that other company will be exempt as to 50% of its gains.  The 40% investment is tested by reference to the same criteria as explained above for the substantial indirect interest test.

It will be particularly useful for larger, more complex fund structures, but may be too complex and costly from an administrative perspective for other funds.

Detailed conditions must be met in either case (for example, that the entity is UK property-rich and other conditions relating to the ultimate owners), and reporting of investor disposals is required once the exemption takes effect.  The election must be made by the fund manager.

While the election has effect, the CIV itself is exempt (or the 99% owned companies, if relevant) together with any fund vehicle in which the CIV has at least a 40% investment, but the exemption is only applicable to the CIV's proportionate holding.

This election remains revocable (by both the fund manager and by HMRC in certain circumstances, most likely in avoidance cases).  In due course HMRC will publish forms to use for this purpose.

If an income payment is made to investors (which is not taxable in their hands), the election is revoked or the conditions cease to be met then a deemed disposal and reacquisition of the interests of the investors in the fund (or the interests of the investors in the company, if the exempt entity is a company) will arise, giving rise to a chargeable gain or allowable loss.

In the case of a breach, this deemed disposal does not occur if the breach of the conditions is remedied within 30 days (with a maximum of four such breaches in any rolling 12 month period).  However, a deemed disposal and reacquisition always arises if the condition which ceased to be met was the 75% property richness condition.  There is also a 9 month temporary breach period, which enables the fund to retain its exemption if it intends to (and does) cure the breach, but unlike for the 30 day cure period a deemed disposal will still occur even if the breach is remedied.

In some circumstances tax due on these deemed disposals is deferred (for example, until money is paid to the investor or the fund is wound up.

On leaving the regime, there is a market value rebasing of the UK land owned at that date (save where the fund/company leaves the regime by reason of HMRC revoking the exemption), but only where the exemption election has had effect for at least five years and the assets have been held for and covered by the election for at least a year.

Conclusion

The taxation of gains made by non-UK residents on UK real estate represents a major shift of tax policy, but is an unsurprising move on the part of the government.

The government listened to concerns of industry during the consultation period and the new rules contain a number of provisions that are helpful to taxpayers, particularly trading groups and real estate funds.  However, there are (as is always the case with complex legislation) potential devils in the detail.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions