An extract from The Real Estate Investment Structure Taxation Review, 2nd Edition

Asset deals versus share deals

i Legal and corporate tax framework

The taxation of income from UK real estate is governed by the core UK corporation and income tax legislation. Non-UK resident investors have historically been subject to the income tax regime, with the corporation tax rules applying only to UK incorporated and UK resident companies.

Although the rates of taxation under the income and corporation tax regimes differ, the core principles governing the computation of taxable income are largely the same for all types of investor. One key exception to this has been that measures introduced to implement Actions 2 and 4 of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting Project are contained within the corporation tax regime and do not currently apply to income tax payers. In April 2020, corporation tax on income was extended to all corporate non-UK resident investors in real estate, at which point the regime for UK and non-UK corporate investors was to a large extent be harmonised.

The rates for tax on capital gains also differ, with one rate applying to companies and another to individuals, but the same legislation governing the computation of chargeable gains applies to all tax payers.

The indirect tax rules are contained in the UK's domestic VAT legislation and various statutes that cover transfer taxes. Certain taxing rights have been devolved to the Welsh and Scottish governments, including transfer taxes, resulting in different regimes applying to the acquisition of real estate in these three regions. Although the rates vary, in broad terms the Scottish and Welsh regimes have largely been modelled on the English one and the legislative framework is similar in all three regions. Following the departure of the UK from the EU on 31 January 2020, the UK entered into a transitional period until 31 December 2020. At this point, subject to any extension of the transitional period, the UK will leave the EU VAT regime. Nevertheless, it is expected that much of the domestic VAT legislation governing supplies of real estate will be retained.

ii Investment in real estateTax on acquisitionStamp duty land tax

Transfer tax is payable on the acquisition of a direct interest in real estate in the UK. Historically this tax was stamp duty and applied to English, Scottish, Welsh and Northern Irish properties. Stamp duty was a somewhat antiquated tax, and stamp duty mitigation was relatively straightforward and very common in commercial real estate transactions. The UK government responded to this by introducing a new transfer tax for real estate, SDLT, in 2003. In recent years, the power to levy a transfer tax has been devolved to the local Welsh and Scottish governments, and now these two regions have their own transfer tax: land transaction tax (LTT) in Wales, and land and buildings transaction tax (LBTT) in Scotland, with SDLT now applying only in England and Northern Ireland. Although the Scottish and Welsh regimes are independent, they are based closely on the original SDLT regime, with the main difference often being in the rates. The top rate for acquisitions of commercial property in England, Northern Ireland and Scotland is currently 5 per cent, and in Wales 6 per cent.

SDLT2 applies to all acquisitions of UK real estate, with the relevant rates applying in a 'slice' system to the consideration provided. For English and Northern Irish commercial property, the first £150,000 of the consideration is chargeable at zero per cent, the next £100,000 is chargeable at 2 per cent and the remaining balance is chargeable at 5 per cent. So, for example, if the consideration is £100 million, the SDLT charge will be just under £5 million.

SDLT is payable on consideration in all forms provided for the acquisition, including the assumption or discharge of debt or other liabilities, and the provision of consideration 'in kind', for example development works or another land interest. There are various reliefs, for example for charities and certain transactions (such as the lease element in a sale and leaseback) but none of these are likely to be applicable on the straightforward purchase of a commercial property by an investor.

Where VAT is payable on the purchase price for property, SDLT is payable on the VAT-inclusive price and cannot be recovered. The acquisition of commercial property is often not subject to VAT under the rules for transfers of going concerns and the main benefit to a purchaser of obtaining this treatment is the SDLT saving.


The supply of land in the UK is exempt from VAT unless the seller has 'opted to tax' the property. In most cases, the owners of commercial property will 'opt to tax' their property. This means that any supplies they make with the property, including lettings to tenants and sales to purchasers, will be subject to VAT (at a current rate of 20 per cent), and the owners can recover VAT incurred on costs related to the lettings and sale.

Where a seller has opted to tax a commercial property, the sale will not be subject to VAT provided that the sale meets the conditions to be the 'transfer of a going concern' (TOGC). Where a sale is a TOGC, it is not treated as a supply for VAT purposes, and no VAT is payable on the purchase price even though the seller has opted to tax the property. The conditions for TOGC treatment are as follows.

The seller must use the property for the purposes of a business and the buyer must intend to carry on the same kind of business with it. Where a property is sold subject to a lease to an unrelated occupational tenant and that lease will remain in place after completion, the property will usually meet the 'business' test for these purposes.

Where the seller is VAT registered, the buyer must be registered or as a result of the transaction be liable to be VAT registered. If the purchaser entity is not VAT registered by the time of the supply of the property (which for VAT purposes will usually occur on completion), it will nevertheless be liable to be registered for VAT where it is a non-UK entity if it expects to make taxable supplies of any value in the following 30 days. For these purposes, where a non-UK entity acquires a property that is let, the UK tax authority (HMRC) treats the buyer as making taxable supplies within 30 days of acquisition (even if no rent is actually payable by the tenant in that period). Therefore, a newly established non-UK holding vehicle should meet the VAT-registration condition where the property is let.

Where the seller has opted to tax the property, the buyer must also opt to tax the property and notify the option to tax to the UK tax authority on or before completion of the sale (the date can be earlier in some circumstances where a deposit is payable). Opting to tax a property is a straightforward process and involves completing the relevant form and submitting it to HMRC. For new entities that are registering for VAT, the option to tax notification is usually submitted at the same time as the application for registration.

The buyer must also confirm to the seller that a certain anti-avoidance provision in the legislation does not apply to it.3 Under this provision, a person's option to tax can be disapplied in certain circumstances, including where a property is let to a related party of the landlord, and at least 80 per cent of the tenant's business activities carried on at the property are not taxable for the purposes of VAT. Provided that the occupational tenants of a property are not connected to the buyer and there are no arrangements for tenants to contribute towards any works undertaken by the landlord at the property, this confirmation can be given and TOGC treatment will be available.

As a result of registering for VAT and opting to tax the property, the buyer entity will in the future charge VAT to its tenants on their rent, and will be entitled to recover the VAT it incurs on property management fees and its other property-related costs. The buyer will be required to file VAT returns with the tax authority on a quarterly basis. Each quarter, the buyer will account for the VAT charged by it to its tenants on their rent, net of the VAT incurred on expenses of its business.

Holding periodTax on rental income

Non-resident individuals investing in UK real estate are currently subject to UK income tax on their rental profits, with the top rate currently 45 per cent.

Prior to April 2020, non-resident corporate investors in UK real estate were also subject to UK income tax on their rental profits. The basic rate, 20 per cent, applied to corporates. Since 6 April 2020, non-resident corporate owners of UK real estate have been subject to UK corporation tax, rather than income tax. The main differences in the two regimes are that the corporation tax rate is currently slightly lower than the income tax rate, at 19 per cent, and the corporation tax regime has more anti-avoidance provisions that could limit the tax relief available in respect of any related-party financing.

An investor's taxable rental profits will be calculated in accordance with generally accepted accounting practice, subject to any specific tax rules. It should be noted that under accounting rules, profit recognition will not always reflect the amount of rental income received in a period. For example, where a lease contains a rent-free period, accounting rules require the rent payable to be recognised over the term of the lease (including the period in which no rent is received).

Non-resident landlord scheme

The UK operates a tax withholding system for non-resident investors in real estate, known as the Non-Resident Landlord Scheme (NRLS). Under this scheme, tenants and letting agents of real estate owned by non-UK residents are required to deduct income tax at the basic rate (20 per cent) from payments of rent to their landlords, unless they have received a direction from the UK tax authority to pay rent gross. Non-resident landlords can apply for permission to receive rent gross and this is almost always granted to newly established entities. Where no direction to pay rent gross has been given, the tax withheld by tenants or letting agents is credited against the landlord's liability to account for tax on their rental profits.

Although non-resident corporate landlords are now within the UK corporation tax regime in respect of their UK property rental income, the NRLS will continue to apply to them.

Rental income: tax deductions

Deductions against an investor's taxable income (under both the income tax and corporation tax regimes) will be available for the items set out below.


Costs of a revenue nature incurred for the purposes of the property rental business, such as management fees, will be deductible against the company's taxable rental profits.

Finance costs

Investors can also claim deductions in respect of interest and other finance costs incurred for the purposes of acquiring the property. There are various rules that restrict the amount of tax relief on interest costs, particularly where the financing is provided by a related party.

Rental income: limitations on tax deductionsTransfer pricing

Under the transfer pricing regime, where the interest rate or quantum of related-party lending is not on arm's-length terms, interest in excess of what would have been payable in an arm's-length loan is not deductible.

Corporate interest restriction

The corporate interest restriction (CIR) rules can also limit the amount of tax deductions available. The CIR is part of the corporation (rather than income) tax regime and so has applied to non-resident corporate investors since April 2020. These rules apply where a corporate group's UK interest expense exceeds £2 million per year. For these purposes, a group will include a parent company and all its consolidated subsidiaries. If the annual interest payable by a group to third-party lenders and on any shareholder debt is no more than £2 million, the CIR regime will not apply.

If a group's annual interest expense is higher than £2 million, the CIR regime will apply. The rules are complex but in broad terms, a group that is subject to the regime can elect for one of two 'barriers' to apply to it. The first is the 'fixed-ratio rule', under which a group can obtain deductions for interest expense up to 30 per cent of its UK tax earnings before interest, tax, depreciation and amortisation (EBITDA) (effectively the operating profit from the property). The other barrier is the 'group ratio' under which the group can deduct a percentage equal to the proportion its external borrowing bears to the group's EBITDA. This barrier enables some groups whose third-party borrowing costs exceed 30 per cent of their UK taxable EBITDA to obtain relief for a higher percentage. A group can choose which barrier to use each period. Both barriers are subject to a 'debt cap', which effectively prevents groups from loading up their UK subsidiaries with debt.

Under the group ratio, related-party debt is disregarded when calculating the group's external borrowing. The effect for holding structures is likely to be that relief for shareholder debt will only be available under the CIR to the extent that annual interest under any third-party financing is less than 30 per cent of EBITDA.

There is an exemption from the CIR that applies to certain companies that let real estate and meet various conditions. The exemption extends only to interest payable to non-related parties, and so effectively ensures that qualifying companies can claim interest deductions in respect of all their bank debt, regardless of the outcome of the fixed ratio and group ratio rules. This exemption could be helpful in years when the buyer group's EBITDA is very low, for example during a period of refurbishment.


The corporation tax regime also contains a set of rules designed to counteract tax advantages relating to hybrid arrangements. These rules can work to deny deductions for interest on related-party loans where the payer is subject to UK tax and the payee is not. This includes where the entities are ultimately funded by hybrid instruments, including instruments that are treated as debt in the jurisdiction of one party to the instrument and equity in the jurisdiction of another party.


As noted above, non-resident individuals are subject to UK income tax on rental income received from directly held UK real estate, or real estate held through a transparent vehicle such as a partnership, at the rates applicable to UK-resident individuals. Individuals will remain subject to the income tax regime following the extension of the corporation tax regime to non-resident property owning companies in April 2020. As such, they will not be subject to the corporate interest restriction or hybrid rules in respect of the funding of their investments.

Withholding tax

UK withholding tax applies to the payment of 'UK source' interest on loans with a term of more than one year. A number of factors are relevant when determining whether interest has a UK source, including the residence of the debtor, the location of any security provided for the debt and the governing law of the loan contract. Interest on a bank loan is generally considered to have a UK source if it is secured on UK real estate, so the interest paid by most investors in UK real estate to their lenders will fall within the withholding regime. There are some important exceptions: no withholding tax is payable if the lender in question is a UK bank or company, or a non-UK entity lending through a UK establishment (e.g., a non-UK bank lending through its London branch). Further, if the lender is based outside the UK in a jurisdiction that has a double tax treaty with the UK, the treaty may reduce the rate of withholding tax that is payable (often to zero per cent).

Although case law4 has caused some uncertainty over what constitutes UK source interest, it is still generally held that where a non-UK resident entity pays interest to a non-UK lender, the loan is not secured on assets located in the UK, the interest is paid to and from accounts outside the UK, and the loan is governed by the law of a non-UK jurisdiction, the interest is not UK-source, even though it may be funded by payment of rents by tenants of a UK property. On this basis, it is usually possible to ensure that interest on shareholder debt used to finance real estate investments is not UK source and remains outside the scope of withholding tax.

Capital allowances

An investor within the charge to UK tax that carries on a qualifying activity (such as a property rental business) can claim capital allowances on qualifying expenditure incurred on fixtures that are 'plant and machinery' that it uses for the purposes of carrying on that activity (e.g., lifts, fire alarms). Capital allowances are a form of tax relief for the depreciation of these assets, with available allowances reducing the relevant company's taxable income for the period in which they are claimed.

Qualifying assets are divided into two groups: plant and machinery in the 'main rate pool'; and long-life assets and integral features in the 'special rate pool'. The rate of written down allowance in the pools is 18 per cent and 6 per cent per year respectively, each calculated on a reducing balance basis. The balance of allowances available to a company each year is known as its 'tax written down value'. A company can elect in each period whether to claim any available allowances.

For example, if a company has incurred £10,000 on qualifying assets in the main rate pool, in the first year the company can deduct £1,800 (18 per cent × £10,000) from its taxable rental profits. The tax written down value in the second year is £8,200 (£10,000 less £1,800 claimed in the first year). In the second year, the company can claim £1,470 (18 per cent × £8,200), and so on in future periods.

When fixtures are transferred on the sale of a property, it is possible to transfer the available allowances to the transferee, by the entry into of an election (a Section 198 election), under which the parties elect to treat the part of the sale price attributable to the fixtures as equal to the tax written down value of the fixtures at the time of transfer. The same election can be used to ensure that the seller retains the benefit of any remaining allowances.

An investor within the charge to UK tax that carries on a qualifying activity (such as a property rental business) can also claim capital allowances on qualifying expenditure incurred on the construction or acquisition of a structure or building first used for non-residential purposes. Construction must have started on or after 29 October 2018 and the qualifying expenditure must also be incurred on or after that date.

These allowances, referred to as structures and buildings allowances (SBAs), are claimed at a flat rate of 3 per cent annually over a period of up to 33.3 years. Broadly, investors purchasing unused structures or buildings from developers may claim SBAs on acquisition costs. If the structure or building has already been brought into use, the investor may claim SBAs on the developer's construction costs (treated as qualifying capital expenditure incurred by the investor). Separately, investors may also claim SBAs on renovation costs provided the relevant building or structure was first used for non-residential purposes and continues to be so used. Unlike allowances on plant and machinery, any SBAs claimed are added to the amount of the sales proceeds when calculating an investor's taxable gain on a disposal of the property.

Tax on exitCapital gains

Until recently, disposals of UK commercial real estate by non-UK resident investors were not subject to UK capital gains tax, giving non-UK investors a material advantage over their domestic peers. With effect from April 2019, the UK capital gains regime was extended to cover gains realised by non-residents on both direct disposals of UK real estate and indirect disposals. This represented a major shift in the UK tax landscape, but it has aligned the UK with most other common investment jurisdictions. Certain classes of investor are exempt from UK capital gains tax, namely certain pension funds and charities, and sovereign entities, but all other non-UK investors are prima facie within the scope of UK tax on their UK real estate gains.

The rates are the same as for UK resident investors in commercial real estate, namely 19 per cent for corporates and a top rate of 20 per cent for individuals. Where the non-resident investor held the property prior to April 2019, the taxable gain will be calculated by reference to the market value of the property on 5 April 2019, unless the investor elects otherwise. So for investors whose properties are standing at a loss at that date, it will be in their interests to elect to use their original cost rather than the April 2019 value when computing their taxable gain.

Indirect disposals are disposals of shares or interests in a 'property rich' vehicle. For these purposes a company is property rich if at least 75 per cent of the gross market value of its assets derives from UK real estate. Value is traced through layered structures, so that a company will be property rich if its sole asset is a shareholding in a subsidiary that holds real estate. There are anti-avoidance rules aimed at the artificial manipulation of a company's balance sheet designed to prevent a company from being property rich.

In some cases, gains on indirect disposals will only be taxed where the person making the disposal owns at least 25 per cent of the vehicle in question, or has owned 25 per cent during the two-year period prior to the disposal. Any interests held by an investor's related parties are aggregated for these purposes. This 25 per cent threshold does not apply, however, in most cases where the asset in question is held in a 'collective investment vehicle'. A 'collective investment vehicle' is broadly defined and will include most joint venture and fund entities, as well as real estate investment trusts (REITs). The effect of these rules is that in most co-investment cases, all investors will be subject to UK capital gains tax on a disposal, however small their interest.

There are two exemptions available to non-resident investors making indirect disposals where the property in question is used in a trade. These exemptions will be valuable to investors in property-rich businesses such as hotels and care homes.

Substantial shareholding exemption

The substantial shareholding exemption (SSE) is part of the main UK capital gains tax framework and applicable to UK and non-UK tax payers. It is available to corporate sellers only, on the sale of shares in companies that are trading. There are various conditions that must be satisfied: in broad terms the main conditions are that the seller must have held at least 10 per cent of the ordinary share capital of the investee company for a period of 12 months, and the investee company or group must have been trading for 12 months. The investee company will generally be treated as trading if at least 80 per cent of its activities are trading in nature.

The SSE will also be available in some circumstances on the disposal of a property-rich company, where the company is not trading. Where at least 80 per cent of the company making a disposal is held by certain categories of investors, the SSE is available on the sale by that company of any subsidiaries of the company (whether trading or non-trading), and where between 25 and 80 per cent of the seller company is held by qualifying investors, a proportionate amount of its gain will be exempt from tax, reflecting the proportion of these investors' ownership. Qualifying investors for these purposes are broadly institutional investors that are exempt from UK capital gains tax, including certain pension funds, charities and sovereign immune entities. The extension of the SSE to vehicles held by these entities provides an efficient route for investment in real estate by these investors.

Trading exemption

This exemption is similar to the SSE, although as an exemption that only applies to non-residents on indirect disposals of property-rich entities, the conditions are more specific to the property in question. The investee's property must be used for the purposes of a trade that the company has carried on for at least a year prior to the disposal, with no more than 10 per cent of the company's real estate (by market value) being used for non-trading purposes. Unlike the SSE, there is no minimum holding period for this exemption, and it is available to all non-resident investors, including individuals.

Treaties and anti-forestalling

Most double tax treaties to which the UK is a party permit the UK to tax non-residents on both direct disposals of UK real estate and disposals of vehicles that are UK property rich (with some treaties containing exceptions for indirect disposals, for example where the vehicle in question is regularly traded). A small number of treaties do not allow the UK to tax gains on indirect disposals, the most prominent of these being the UK–Luxembourg treaty. The domestic rules contain an anti-avoidance measure preventing new structures being set up in Luxembourg to take advantage of this treaty protection, and the UK–Luxembourg treaty is in the process of renegotiation. However, until the treaty is amended, structures using Luxembourg holding vehicles that were established before the extension of UK capital gains tax was announced in November 2017 should be able to benefit from treaty protection, with the result that gains from indirect disposals of real estate investments will not be taxed in the UK.

Regime for funds

A particular concern when the extension of capital gains tax to non-resident investors was announced arose in relation to the application of the new regime to fund and co-investment vehicles, which commonly use non-UK holding vehicles for their real estate investments. UK pension funds and other investors that are exempt from UK capital gains tax hold a large proportion of their UK real estate investments through these structures. A particularly popular vehicle is a unit trust based in the Channel Islands (Jersey or Guernsey) or the Isle of Man. These vehicles involve a corporate trustee based in the relevant jurisdiction holding the assets on behalf of the investors, whose interests consist of units, with each unit entitling its holder to a proportionate amount of the asset's income and gains. These vehicles are particularly popular as they can be structured in a way that makes them transparent for UK income tax purposes. For UK capital gains tax purposes, they are treated as companies. Provided they were properly managed outside the UK, these unit trusts would (prior to April 2019) have been outside the scope of UK capital gains tax. This means that tax-exempt investors such as pension funds can receive their share of the fund's income without any tax at the level of the unit trust, and similarly any gains realised by the sale of the asset would have been returned to the investors without tax at fund level.

Without special rules, these vehicles, and others commonly used in real estate fund and joint venture structures such as non-UK companies, would have become subject to tax on gains, leading to tax-exempt investors suffering tax at fund level where they would not if they held assets directly. Transfers of these vehicles do not attract SDLT and so a sale would typically be structured as the sale of the unit trust rather than the real estate asset. However, with these vehicles now within the scope of UK capital gains tax, exempt investors could have suffered from sale prices being discounted by buyers for latent gains in the structure. In addition, funds with multiple layers of holding companies and master holding companies could have suffered multiple tax charges on a single gain as it was returned up the structure to investors.

A special regime for funds and joint ventures has been included in the extended capital gains tax rules to address these issues. Funds and joint ventures can enter into elections that have the effect of shifting gains in the holding structure up to the level of investors. This allows tax-exempt investors such as pension funds to receive their share of gains without incurring tax at fund level. This ensures that these investors, as well as non-UK investors who are exempt from UK capital gains tax (certain charities, and sovereign immune entities) can continue to invest in UK real estate via funds and joint ventures without suffering more tax than they would on direct investments.

There are two types of elections for funds: transparency election and exemption election.

Transparency election

This election applies to any collective investment vehicle that is transparent for UK income tax purposes but is treated as opaque for capital gains purposes. The most obvious example, and the main target of this election, is the Channel Islands unit trust referred to above. These entities can elect to be transparent for UK capital gains tax purposes, and where they do so the investors in the vehicle will be treated as if they hold the underlying real estate directly. This means that investors who are exempt will not be taxed on disposals by the vehicle and as the vehicle is transparent there will be no latent gain in the vehicle that could lead buyers to discount price on an acquisition of the vehicle.

Consequently a sale structured as the sale of the units in a unit trust will still be available in most cases as a tax-efficient exit route. The parties are in the same position from a capital gains position as they would have been on a direct sale of the asset and the buyer benefits from an SDLT saving because the acquisition of units is not subject to SDLT.

Exemption election

This election applies to non-UK vehicles that are opaque for capital gains tax purposes (most obviously companies). Vehicles that meet the relevant conditions are exempt from capital gains tax. Gains realised by the structure are subject to tax when they are distributed to investors or when the fund ceases to qualify for exemption. The tests to be met by a fund wishing to benefit from this exemption election are complicated, but in broad terms it is open to structures that meet either a widely held or a widely marketed test. The structure in question must have a non-UK holding entity and be property rich. In certain circumstances, a fund that is held as to more than 25 per cent by investors resident in a jurisdiction with a double tax treaty preventing the UK taxing indirect real estate disposals will not be entitled to make the election.

Where a fund has elected to be exempt, any gains it or any of its subsidiaries realise will be exempt, as will its share of gains of any joint venture in which it holds at least 40 per cent. A further advantage of the exemption regime is that if the fund disposes of a property-holding subsidiary, that subsidiary obtains a rebasing of its real estate assets, so that its base cost is equal to market value at the time of exit. This means that future buyers will not suffer from any latent gain in the subsidiary.

Funds that meet the conditions and make the exemption election must comply with various reporting obligations, providing information, inter alia, about the tax status of their investors to the UK tax authority.

VAT on exit

A sale of UK commercial real estate will be subject to VAT if the seller has opted to tax it, which will generally be the case (see above). However, provided that at the time of the sale the property has at least one tenant in occupation, it should be possible to structure the sale as a TOGC so that there is no VAT on the price. The VAT incurred on the costs of selling the asset should be recoverable.

A sale of shares in a company (or units in a unit trust) is not subject to UK VAT.

SDLT on exit

On an asset sale, the buyer would be subject to SDLT at the prevailing rates (currently 5 per cent for commercial property) on the consideration provided. Indirect disposals, in the form of the sale of a property holding company or unit trust, are not subject to SDLT. For this reason, UK commercial real estate transactions are commonly structured as the sale of the holding vehicle. The sale of a partnership holding real estate is generally subject to SDLT, and therefore it is unusual for UK commercial real estate investments to be held directly by partnerships, although these are popular vehicles for funds and joint ventures.