In the Budget, the Chancellor launched a three-pronged assault on high value UK residential properties that are 'enveloped' in a company or other 'non-natural person'. As a result, many UK individuals, non-UK domiciliaries, and offshore trustees have been anxiously awaiting the publication of fuller details. A surprisingly slim Consultation Document appeared yesterday entitled 'Ensuring the Fair Taxation of Residential Property Transactions' (no mention there of the fact that the annual tax will effectively operate as a kind of wealth tax). It was already known that the new annual charge and the new capital gains tax (CGT) charge would be coming into effect from next April, and so the immediate question is whether those who are affected are now in a position to consider whether action needs to be taken before then.
It is our experience that briefings that are circulated immediately new proposals appear cannot provide the kind of thoughtful analysis of the implications that we like to give. Particularly when a Consultation Document is so short (the substance is a scant 20 pages), time is needed to tease out implications that are not immediately obvious, and to identify the significance of things that are not said. So the purpose of this briefing is to alert readers to the fact that the Consultation Document has been published, to sketch in some of the headlines, and to let you know that we will be preparing a fuller briefing which we expect to send out shortly. At that point it should be possible to begin to review existing property structures, and to identify whether particular individuals or families would, or would not, benefit from changes to the structure before the new laws come into effect next April.
Perhaps the first important thing for those affected (or likely to be affected) by these new rules is to know how the picture will develop before the new rules are finally in effect, as this will be a moving target in the coming months.
The present consultation lasts until August and we are promised draft legislation (again, for consultation) in the Autumn. However, we will not know the rates (the Consultation Document's use of the plural is interesting) of CGT to be applied to these properties until the next Budget - ie probably only a matter of two or three weeks before the rules come into effect. This will make it important to do structural planning in good time, allowing it to be tweaked, if necessary, at the last minute.
The first key valuation date for deciding whether a property that is already in an 'envelope structure' is worth over £2 million, and so within the new rules, will be 1 April 2012 - ie the first April that has just passed. This is helpful in that, rather than trying to plan based on an estimated figure as at April 2013, it allows planning in the coming months to be done using a known figure, so that the interaction of the various taxes can be considered more accurately: for it is the interaction of the various taxes that apply that will determine the cost of the new rules in any particular case, not a simple calculation of how much the combined CGT and annual charge would be.
Owners of 'enveloped' residential property in the UK - the proposals
In order to tackle the so called enveloping of high value properties into companies and non-natural persons in order to 'avoid paying a fair share of tax', the Government has adopted a threefold approach:
- with effect from 21 March 2012 a new 15% rate of stamp duty land tax (SDLT) applies on purchases of UK residential properties worth over £2 million by non-natural persons;
- from 1 April 2013 an annual charge will apply to UK residential properties valued at over £2 million owned by non-natural persons; and
- from 6 April 2013 the CGT regime will be extended to gains on the disposal of UK residential property, and shares or interests in such property, by non-natural persons who are non-UK resident.
The aim is to discourage enveloping of property and all three proposals will run in tandem. Any new purchases of properties worth more than £2 million by a non-natural person will suffer a 15% SDLT charge on the purchase, the annual charge based on value will then be payable going forward and, if the non-natural person is non-UK resident, disposals of the property will now be subject to CGT. Non-natural persons who acquired relevant property before Budget Day will be subject to the annual charge and, if non-UK resident, CGT on disposal.
Legislation to effect the higher rate 15% SDLT charge is included in the Finance Bill 2012 and from that we know that 'non-natural person' includes companies, collective investment schemes and partnerships in which a non-natural person is a partner. However the 15% charge will not apply to the purchase of a property by a trust even though one or more of the trustees is a company. In the Consultation Document it is suggested that same test for non-natural person should apply for the purposes of the annual charge. The test for the extension of the CGT regime is less certain (see below).
An annual charge will come into effect on 1 April 2013 and will be payable at the start of the period of account, ie by 15 April of each year. It is proposed that the charge will operate on a pro rata basis so that if the property is sold during the year a repayment of part of the charge can be claimed.
A return will be required each year for each relevant dwelling within the charge owned by the non-natural person. The return must include information on the property: its address, Land Registry title, details of the 'beneficial owners' of the property and their address if different from the property address. We do not yet know whether this will require simply details of, say, the company which owns the property or whether HMRC will need to be informed of the ultimate beneficial owners, for example, details of the shareholders or, if the company is held by a trust, details of that trust.
The levels of the annual charge will be set at £15,000 pa for properties valued at between £2 - 5 million; £35,000 for properties valued at between £5 - 10 million; £70,000 for properties valued at between £10 - 20 million; rising to £140,000 for properties worth more than £20 million. The annual charge will be indexed to the Consumer Price Index (CPI) and increased in April each year based on the CPI of the previous September. This will commence from the second year of charge (namely 1 April 2014).
Introducing an annual charge on capital values means that the UK now has its first form of wealth tax (a form of tax found in many European jurisdictions including France and Spain).
Valuation issues will be key for properties already in such structures particularly for those on the cusp of the different band levels. The valuation required for the first year of the charge will be the market value of the residential property on 1 April 2012 for properties already in an envelope structure, or the acquisition value if acquired after that date. Properties retained in these structures will be revalued every five years so a further valuation will not be required until 1 April 2018 where the relevant valuation date will be 1 April 2017. Owners of properties which were bought for less than £2 million will need to check the current value of the property and if the value is approaching the £2 million level may need to obtain a professional valuation to protect themselves. A reminder should also be set to ensure that the position is reviewed in April 2017 if the property is still owned at that time.
New CGT charge
The proposal is for CGT to be extended to certain non-natural persons who are not resident in the UK for tax purposes. Non-natural persons who are resident in the UK will already be subject to tax on gains realised on the sale of residential property, either CGT or corporation tax on capital gains.
Will the CGT charge extend to offshore trusts?
The Consultation Document notes that to support the annual charge the categories of non-natural person to whom the CGT regime will be extended will 'necessarily have to include those categories that are subject to the annual charge' and asks what further categories might be included. From this one might infer that offshore trusts, including those with corporate trustees, would as a starting point be excluded. However, it would in fact seem that the Government are expecting to extend the new CGT charge to apply to offshore trusts which hold relevant residential property, and indeed the opportunities for avoidance if trusts were not included under this head of charge are obvious.
Current CGT avoidance legislation already ensures that gains accruing to certain non-resident natural persons can effectively be charged to CGT, for example by virtue of the rules under which settlors or beneficiaries of non-resident trusts can be charged to tax on gains accruing to the trustees (sections 86 and 87 Taxation of Chargeable Gains Act 1992). The Consultation Document acknowledges that the interaction between the new rules and provisions such as these will have to be considered carefully to avoid 'unnecessary complexity' and 'ensure a sensible prioritisation of charging provisions'.
Section 87 was heavily revised as recently as 2008, and it will be interesting to see how the more detailed proposals will accommodate the Government's pre-existing commitment that there will be no further substantive changes to the taxation of non-UK resident non-domiciliaries (non-doms) during the remainder of this Parliament.
The rate of tax, and latent gains
It is envisaged that the CGT charge will only apply to disposals of residential property where the amount of the consideration for the disposal exceeds £2 million. There is to be no 'grandfathering' of (ie protection for) latent gains that have accrued but not been realised before the extension of the CGT regime. Although the property market as a whole has seen prices fall or remain static in recent years, those at the higher end of the market have seen large increases and substantial gains could have been built up where properties have been held for a longer period of time.
As noted above, the rates of CGT will be confirmed by the Chancellor at Budget 2013: they are not a subject for consultation. The main rate of CGT for individuals and trusts is currently 28%. For the year ending 31 March 2014 the main rate of corporation tax for companies is to be 23% and for smaller companies (those with a profit of less than £300,000) it is due to be 20%. It would seem that there could be a range of rates for the Chancellor to choose from. One approach might be to have a flat rate of CGT applied to all non-natural entities caught by the rules; an alternative would be to use the CGT rate which would have applied to that entity if it were UK resident. How all this will interrelate with rebasing for offshore trusts, latent gains, and the supplementary charge that applies if their gains are not paid out in the year they are realised receives only the most sketchy treatment.
Meaning of 'residential property'
The definition of residential property for these purposes will follow the meaning of 'dwelling' used for the 15% SDLT rate and the new annual charge. The CGT regime will apply to disposals of residential property in enveloped structures irrespective of the use to which it is put, for example it will apply to commercially let residential property. A CGT charge will also arise on gains realised on the disposal of assets which represent, directly or indirectly, relevant UK residential property. This will include disposals of shares, interests or securities in a property owning company where more than 50% of the value of the asset is derived from UK residential property. Losses arising on the disposal of relevant UK residential property will only be available to offset gains on disposals of relevant UK residential property in the same or future years.
In a nutshell: is action needed now?
This outline of the issues will have amply demonstrated that those who are affected should not hasten to make actual changes at this stage, but that once the Consultation Document has had sufficiently close analysis it will not be too early for those who are affected by the new rules to begin to identify how they wish to respond to this new legislation.
The most important first step will be to think back to the reasons why the property was put into a company or a non-natural person in the first place. To what extent are those reasons still valid? Will the disadvantages of the charges outweigh them, or do those reasons still remain compelling? If they do, can the key objectives be achieved in a different way that will be less harshly treated by the new rules?
There is a simplistic view, which the Government seems to share, that properties were put into companies 'to save SDLT'. Actually it saved no SDLT on the purchase itself, only potentially saving SDLT on an onward sale. The reasons for using a structure of this sort were usually more complex and more worthwhile.
They would generally include a mix of:
- inheritance tax protection;
- avoiding the need for a UK probate; and
- reasons connected with another jurisdiction with which the individual or family was connected.
So in deciding what to do now it will be necessary to compare not only costs, but also less tangible benefits such as privacy. Each case will be different and will need to be looked at in the wider family or other context - for example, is this the main family home, or a flat in London only used by a non-dom from time to time? If the UK is not the main base, how long do the family expect to stay in the UK?
The instinctive reaction of many may be to wonder whether they should 'de-envelope' - in other words to take the property into personal ownership. That is certainly what the Government wants people to do. For some it may well be the right course. To get the best result it will, however, be important to identify the tax and other costs of the process of de-enveloping, and then to compare them with the tangible and intangible cost and benefits of either maintaining or altering the structure