Following the surprise announcement on 22 November 2017 that the scope of UK taxation of capital gains is to be extended from April 2019 to non-residents holding direct or indirect investments in UK commercial property, the keenly awaited draft legislation which will implement these changes was published on 6 July. This is a major change in the scope of UK tax for non-resident investors in commercial property and some investors in residential property that were not previously caught by the non-resident CGT rules introduced in 2015. The legislation also confirms that ATED related capital gains tax will be abolished. The draft legislation includes some welcome changes from the original proposals, but there are also still some substantial outstanding issues, particularly in relation to how the legislation will apply to collective investment schemes.
The draft legislation imposes a charge to either CGT or corporation tax on non-UK residents making a direct or indirect disposal of an interest in UK land. Indirect disposals will be caught where the asset disposed of is:
- an interest in a property rich entity (i.e. the asset derives directly or indirectly at least 75% of its value from UK land); and
- where the person has a substantial indirect interest in that entity (substantial being an interest of 25% or more applying a two year look back).
The new rules will apply to gains from disposals made from 6 April 2019 onwards. There will be a rebasing of direct or indirect interests in UK property as at 5 April 2019 but to reduce the burden for taxpayers of obtaining new valuations there is also the option of electing for original cost to apply. The original cost option applies to both indirect and direct interests (under the original proposals rebasing to market value at 5 April 2019 was mandatory for indirect interests). However, for indirect disposals, if using original cost produces a loss, this is not an allowable loss.
Existing tax reliefs and exemptions such as the substantial shareholding exemption and "no gain no loss" treatment for intra-group transfers should apply to non-UK resident persons as they do for UK resident persons. One of the most notable changes from the original proposals is the introduction of a further exemption for indirect disposals where a company's UK property assets are used in or for the purposes of a trade (eg companies operating retail, utility and hotel businesses). For the exemption to apply:
- all of the interests in land (other than those of an insignificant value) must be used in a qualifying trade;
- the trade must have been carried on for at least one year prior to the disposal; and
- it should be reasonable to conclude that the trade will continue to be carried on after the disposal.
To determine if a person has a substantial interest the investor's interests are to be aggregated with those of connected persons. The definition of connected persons is slightly narrower than what was initially proposed but it includes situations where two or more persons are "acting together" to secure or exercise control over the company. This may be a difficult test for certain minority investors to establish. Transactions within the charge also need to be reported within 30 days of a disposal, so investors may not have long to ascertain their tax position.
Core proposals for collective investment vehicles
The summary of responses to the consultation confirms that any final legislation will contain special rules for non-resident investors in collective investment schemes and, where appropriate, exempt investors investing in other investment structures. However, this has not yet been drafted which is problematic as both UK resident and non-UK resident investors need to be able to review existing structures in advance of April 2019, and understand their future UK tax position.
The summary of responses sets out the following core proposals for introducing specific rules for collective investment schemes:
- Offshore funds which are transparent for income (eg JPUTs which confer absolute entitlement to income on unit holders) will be able to elect for transparency for the purpose of capital gains as regards the position of non-UK resident investors (but UK resident investors will retain their current tax treatment).
- Offshore funds that are not closely held and which agree to reporting requirements will be able to elect for special tax treatment, whereby gains made by the fund (or entities below it) will not be taxable but the investor will be taxed on disposals of their interest in the fund (this would apply whether the fund was transparent or opaque).
- For exempt investors who have invested in other structures which embody the same principles of joint investment, the government will consider "other solutions".
- The 25% or more substantial indirect interest test will not apply to investors disposing of interests in funds (at least where the fund is clearly a UK property fund) on the basis that those who invest in such funds know that they are investing in UK land (this is a departure from the original proposals and, presumably, is intended to catch all non-UK resident investors who invest in, for example, UK REITs but will have minority interests).
The government is trying to deal with difficult issues in relation to both UK and non-UK exempt investors holding interests in offshore structures and it appears willing to address these issues through further consultation with stakeholders, but it remains committed to a 6 April 2019 commencement date for the new regime.
Where does this leave offshore structures?
A non-UK resident investor may not be caught by the indirect disposal rules if there is a double tax agreement (DTA) in place between the UK and the country of residence of the non-resident person making the indirect disposal of UK property and the DTA restricts taxing rights on such indirect disposals to the jurisdiction of residence of the person making the disposal (eg the UK-Luxembourg DTA). Any UK legislation imposing a tax charge on the indirect disposal is then overridden. However, the government has confirmed that it is in discussions with Luxembourg regarding the provisions of the UK-Luxembourg DTA and this highlights the likelihood of change to these provisions which may affect existing structures that would otherwise fall outside the charge to UK tax under the new proposals.
The anti-forestalling principles that have applied since 22 November 2017 to abusive "treaty shopping" arrangements have now been drafted. However, it remains unclear whether and to what extent the anti-forestalling rules would apply to the exercise of a legitimate choice of investment jurisdiction (such as Luxembourg) in the context of what is considered to be an abuse of the object and purpose of an applicable DTA.
Investors will need to reassess structures and consider if they are caught by the new rules. However, as we await the outcome of further discussions between HMRC and stakeholders in relation to the collective investment scheme proposals, this will be hard to do until these proposals have been finalised.