As part of the Autumn Budget 2017, the Chancellor announced plans to bring gains realised by non-residents on the disposal of all UK property within the scope of UK tax. The intention is to create one regime for disposals of interests in residential and commercial property and reduce the incentive for holding UK property in offshore structures in low or no-tax jurisdictions. The proposal is for the rules to apply from April 2019 and for gains arising from that date.
The announcement was followed by a consultation document setting out the proposals in more detail and inviting responses. The consultation period has recently closed. The potential impact on fund structuring is significant, affecting tax treatment at both fund and investor level.
In essence, the government is proposing to introduce rules effective from April 2019 to tax all gains derived from UK immovable property and indirect holdings of such property (over and above the value at April 2019) to UK capital gains tax or corporation tax, regardless of the residence of the party disposing.
Under current law, a non-UK resident is not liable to UK capital gains tax on investment gains arising on UK property unless such property is residential property where a specific regime applies and which, subject to a number of exemptions, taxes gains from UK residential property regardless of the residence of the owner. While income derived from UK property is generally subject to UK tax, the beneficial non-resident capital gains tax regime results in the UK being an attractive place for real estate investment by non-residents.
Impact of the proposals
At fund level, funds that are exempt from gains on the disposal of UK commercial property only by reason of not being UK tax resident would be brought within the scope of UK tax. This will likely affect Jersey Property Unit Trust (JPUT) structures, for example.
HMRC has indicated that UK collective investment vehicles which are currently tax advantaged – such as Real Estate Investment Trusts (REITs), Property Authorised Investment Funds (PAIFs), Exempt Unauthorised Unit Trusts (EUUTs) and Authorised Unit Trusts (AUTs) – will continue to benefit from their current arrangements. It may be that these structures are increasingly popular in light of the changes, although factors such as eligibility of assets, permitted investors and regulatory impact will need to be considered on a case-by-case basis. Furthermore, HMRC has confirmed that consideration will need to be given to whether any other changes to the existing rules will be needed to create and coherent and robust regime.
At investor level, the proposed indirect disposal rules are likely to have a noticeable impact. The new rules are aimed at capturing gains on indirect sales of both commercial and residential property where the property is held within an entity and such entity is “property rich” – with 75% or more of gross asset value represented by UK immovable property. The indirect disposal rules are proposed to only apply where the non-UK resident holds, or has held at any point in the last 5 years, at least a 25% interest in the entity (the Indirect Ownership Test).
This means that while there may be no change to the tax regime of funds that are currently not subject to tax due to specific tax codes, the disposal of the interests in such funds by non-UK residents will be subject to UK capital gains tax if the interests pass the Indirect Ownership Test – unless the investor is exempt from capital gains otherwise than through non-residence. For example, on the basis of the proposals, pension fund investors will be protected from tax arising indirect disposals. However, a pension fund may still suffer tax inefficiencies in relation to its commercial returns if the entity itself is taxable.
What happens next?
Consideration will clearly need to be given to the marketing and structuring of real estate funds affected by these proposed changes to disposals of UK property and interests of a certain size in “property rich” vehicles.
The consultation closed on 16 February 2018. The consultation has generated a lot of interest within the funds community and it will only be when the response is published that we have a clearer picture as to the government’s intentions and whether concerns raised by the industry have been taken on board. It is expected that draft legislation will be published as part of the Finance Bill 2019 and take effect from April 2019.