The ever changing landscape of the UK tax treatment of residential property

Since 2012, the Government has sought to address the discrepancy in the UK tax treatment of non-UK and UK resident investors as well as to target all those investing in high value properties while boosting its tax revenues. Writing in the latest edition of the Rothschild Trust Review, Penningtons Manches senior associate Imogen Buchan-Smith looks at the extent of the changes that have been introduced over the last three years and examines the current state of play, including measures that still need to be considered in relation to existing UK residential property holding structures. 

I took a call from a Russian client of mine in January 2011. He was considering buying a £2 million property in Kensington that had recently come on the market, having spent an increasing amount of time in London (although not enough to make him a UK tax resident) and wanting something more permanent, and homely, than a hotel room. After making some further enquiries, we discovered that this property was held by a BVI company and, once some due diligence had been undertaken, the client decided to purchase the shares in the BVI company. My client paid no UK tax on the purchase of the shares and, going forward, provided the property was not let and the client remained non-resident, the ownership of the property would give rise to no UK tax consequences for the client.

This tax treatment would not have been the case for a UK resident investor and this discrepancy has been what the Government has sought to address in the intervening years, as well as targeting all investors in high value properties, while giving a much needed boost to their tax take…

Timeline

On 21 March 2012, George Osborne announced the most significant changes to the UK tax treatment of UK residential property ('residential property') for decades. Corporate property holding structures were the primary target of the 2012 Budget, as the Chancellor made the following announcements:

• a 15% stamp duty land tax (‘SDLT’) charge for properties valued over £2 million (‘high value properties’) purchased in a ‘corporate envelope’ was introduced with immediate effect;
• a consultation on the introduction of:
• a ‘large’ annual charge on those high value properties which were already contained in corporate envelopes (which would be come to be known as the ‘Annual Tax of Enveloped Dwellings’); and
• capital gains tax (‘CGT’) on property held in overseas ‘envelopes’,

was announced.

Mr Osborne continued his quest for the equalisation of the UK tax treatment of non-UK and UK resident investors in residential property by announcing the extension of the CGT regime to non-UK resident investors in property in the 2013 Autumn Statement with effect from April 2015.

Most recently, in the Summer Budget this year, Mr Osborne announced that the UK inheritance tax regime would be extended to non-resident investors holding property via corporate structures, while an extended nil rate band would be introduced for individuals (domiciled and non-domiciled alike) wanting to pass their family home to their children on death, with effect from 6 April 2017.

However, as I mentioned above, it is not just non-resident and corporate investors who have been in the line of fire over the last few years, but all investors in high value properties as well as individuals who are perceived to be wealthy, with the SDLT changes that have been introduced, the proposed restriction on mortgage interest relief for landlords as well as a cap on the availability of the extended nil rate band mentioned above.

Where are we now?

Given the extent of the changes that have been (and have to be) introduced since 2012, the UK tax treatment of residential property can now be both a complex and confusing area to advise on. I summarise below the various taxes that now need to be considered in relation to both existing UK residential property holding structures as well as when considering the appropriate ownership structure for purchasing such properties. 

The Annual Tax on Enveloped Dwellings (the ‘ATED’)

All ‘non-natural persons’ (namely corporates but, importantly, not trustees), irrespective of their residence status, are within the scope of the ATED regime if they hold residential property valued in excess of £1 million (and, from 1 April next year, in excess of £500,000), by reference to its 1 April 2012 value, and are subject to the following annual charges, by reference to the value of the property that they own:

An annual charge of £3,500 will apply to non-natural persons who own property with a value greater than £500,000 from 1 April next year.

Reliefs are available from the ATED regime for non-natural persons which run property development, rental and trading businesses, provide employee accommodation, are charities and own farmhouses. However, such reliefs will only be applicable if the relevant property is not (and is not capable of being) occupied by ‘non-qualifying individuals’ (namely, individuals who are beneficially entitled to the property or are connected with a person who is), notwithstanding whether market rent is paid for such occupation.

SDLT

(A) Non-natural persons within the ATED

If a non-natural person falls within the ATED regime, the highest SDLT rate of 15% will apply on a purchase of the property by the company if the property is valued at £500,000 or more. However, if relief is available from ATED, the normal SDLT rates (as set out below) will apply to the purchase.

(B) Everyone else

Prior to 4 December 2014, SDLT was calculated on the entire value of the property at a rate determined by which band the overall consideration fell within. The system, often referred to as a ‘slab system’, meant that where the consideration fell close to the band thresholds, a small increase in the value of the property purchased would have a disproportionate effect on the amount of SDLT payable.

The new ‘normal’ rates, as mentioned above, are now banded (in a similar way to income tax) as set out below whereby the SDLT rate will be payable on the portion of the property value which falls within each band:

The practical implication of these changes is that the SDLT payable on the purchase of higher value properties has increased. For example, at today’s rates, the purchase of a £3,000,000 property would give rise to a £273,750 SDLT charge, as opposed to the £210,000 charge which would have arisen prior to 4 December 2014. However, the SDLT payable on the purchase of lower value properties is broadly the same as previously.

CGT

(A) Non-natural persons within the ATED

As with SDLT, if a non-natural person falls within the ATED regime, the highest CGT rate (currently 28%) will apply on a sale of the property. However, the value of the property for the purpose of this CGT charge will be rebased as at the property’s 6 April 2013, 2015 and 2016 values for properties worth over £2 million, over £1 million and over £500,000 respectively.

(B) Non-UK resident investors

UK residents have always been subject to CGT on a sale of the UK (and worldwide) assets they own to the extent that those assets have increased in value since acquisition. However, prior to 6 April this year, non-residents were not subject to CGT on the sale of their UK assets. From 6 April this year, all non-residents are now within the CGT regime to the extent that they own residential property (whatever its value and nature – there is no de minimis as there is with ATED and there are no reliefs available, save for principal private residence (‘PPR’) relief, the scope of which I shall come on to explain). However, as the CGT charge will not be retrospective, those non-residents will not be subject to CGT on any gains arising on the relevant property prior to 6 April 2015. A property may be subject to both ATED related CGT and non-residents CGT. However, the ATED CGT charge takes precedence over the non-residents CGT.

In the spirit of equality, PPR relief has been extended to non-resident individuals, such that a non-resident will be able to claim relief on the sale of their main or only UK residence, but only in respect of gains attributed to tax years during which the individual has (or their spouse or civil partner have between them) stayed overnight on at least 90 occasions in the property (or any UK property) owned by the individual. Therefore, non-residents may struggle to satisfy the 90-day test without becoming UK resident for the tax year concerned so the true value of this relief is limited.

Inheritance tax (‘IHT’)

The UK (and worldwide) assets of individuals who are domiciled in the UK are within the IHT net, meaning that, subject to certain exemptions, those assets will be subject to an IHT charge on the individual’s death (currently at a rate of 40%). However, broadly speaking, provided that a non-domiciled individual (or an offshore trust) holds UK property via an offshore company, that property will not be subject to IHT charges as ownership via an offshore company effectively acts as a ‘blocker’ for IHT purposes. For this reason, this has been a standard property ownership structure for non-domiciled individuals. However, as mentioned earlier, the Chancellor intends a complete overhaul of this tax regime with all residential property (whether let and of whatever value) owned indirectly via offshore companies and similar vehicles being subject to IHT from 6 April 2017. How this will be achieved has yet to be seen as, at the time of going to print, the consultation promised by the Government has yet to be published.

However, while the Chancellor may take with one hand, he promises an additional nil rate band (the ‘ANRB’) specifically intended for residential properties with the other…

By 2020/21, it is proposed that an extra £175,000 IHT allowance in relation to the family home will be available on an individual’s death. This will combine with the nil rate band allowance (an amount that can be passed free of IHT on an individual’s death) that every individual has (no matter what their domicile status) to give some individuals a £500,000 allowance when leaving property to children and descendants on death and a combined £1 million for spouses and civil partners. This extension of the nil rate band will be phased in from April 2017. The allowance will be restricted to property that has been the residence of the deceased at some point during their lifetime, so it would not apply to a buy-to-let property (although it could apply to a property which used to be the deceased’s residence, but which was let at the date of death). The draft legislation further provides that when an individual downsizes or ceases to own a home the ANRB would still be available provided the smaller replacement property and/or the proceeds of the sale of the property (or, potentially, whatever they subsequently become) are passed to the deceased’s descendants.

However, there is a catch. Since the Government does not want to be seen to be benefiting those considered to be ‘better off ’, the ANRB will not be available to all. The allowance will therefore be reduced for estates worth more than £2 million at a withdrawal rate of £1 for every £2 over that threshold so that, effectively, the tapering of the allowance means that no relief is available for estates with a net value, in 2020/21, of £2.35 million or more (or £2.7 million on the death of a surviving spouse where the full main residence nil rate band is available to be transferred to the survivor).

Income tax

As mentioned above, although there are certain tax benefits to being a landlord, the Chancellor does not intend these to extend to income tax and the Summer Budget also saw the announcement of changes that will have a significant impact on the net income many landlords generate, with effect from April 2017.

Under current rules, landlords are able to deduct 100% of their finance costs (namely mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans) from rental income received. However, from April 2017, the deductions of interest permitted from profits will be reduced as follows:

• 75% for the 2017/18 tax year;
• 50% for 2018/19;
• 25% for 2019/20; and
• 0% thereafter.

Where does this leave us?

Corporate property holding vehicles

Given the equalisation of UK taxes applicable to UK residents and non-residents alike, and the punitive charges that now apply to corporates, foreign investors may wonder whether the traditional corporate property holding structures are a worthwhile mechanism for holding residential property and the answer is…it depends! The use of corporates is still attractive and, indeed, beneficial from a UK tax perspective where the underlying property is being let on a commercial basis as:

• Income and capital gains tax arising in relation to the property will be capped at the corporation tax rate. This is currently 20% but is set to continue to decrease to 19% in 2017 and 18% by 2020, as opposed to the 28% CGT and 45% income tax rates that can apply to individuals.
• The structure will be exempt from the higher SDLT rate as well as ATED charges.
• All finance costs can be deducted from the company’s taxable profits (the mortgage interest relief restrictions will not apply to corporates).
• There remains the option to mitigate SDLT for a future purchaser of the property through a purchase of shares in the holding company as opposed to a direct purchase of the underlying property.

UK property market