New draft legislation published for technical discussion provides some further detail on the UK Government’s proposed taxation of non-UK residents’ gains on UK property and assets deriving significant value from UK property. Unfortunately, uncertainty remains around the new regime’s application to UK property funds and joint ventures.
Following the Q4 2017 consultation by the UK Government on the extension of UK tax to gains arising directly or indirectly on the disposal of UK commercial property by non-UK tax resident investors, a consultation response and draft legislation have now been published. Whilst significant detail is still in development (and a number of areas are marked for further “exploration” by UK Government officials in additional consultation with industry and advisers), we now have greater clarity on how the new rules (the “NRG Rules”) are intended to apply.
Unfortunately, however, the position in relation to property funds remains unclear. These are to be subject to a special regime, but the detail has not yet been confirmed. The headline points for funds seem to be that:
- in general, non-UK resident investors in UK property funds should expect to be caught by the new regime
- exceptions could include a limited category of exempt investors such as sovereigns and possibly certain categories of non-UK retirement benefit schemes
- the 25% minimum ownership threshold which will apply under the basic rules on indirect disposals (i.e. of interests in property-rich vehicles) may not apply to sub-25% interests in funds. It seems even small shareholders in UK REITs may perhaps be affected
The proposals in relation to funds are still under development, so the position may change. Another area of difficulty with the new rules may arise in joint venture situations. Although in the funds arena it seems likely that an elective entity-level exemption may be available to produce a single layer of UK tax applying only at the investor level, there is currently no such proposal in relation to joint venture holding vehicles. As such, these could produce multiple levels of tax (on the sale of properties and also the redemption of interests in the vehicle by investors), and exempt joint venture investors could as a result be indirectly exposed to UK tax at the entity level. This is acknowledged as a possible outcome by the UK Government, so, although the position is stated to be under consideration, potentially affected investors may need to consider restructuring alternatives.
With respect to the detail published, broadly, the key points are as follows (with the caveat that the position in relation to a property fund and its investors may differ from that outlined below):
The new rules will apply to disposals taking place on or after 6 April 2019.
The rules will apply to direct, and certain indirect, disposals of commercial or residential property situated in the UK. In general, a tax return (and payment on account of UK tax in respect of the relevant gain) will be due to be submitted to HM Revenue and Customs in the UK within 30 days of the relevant disposal.
A re-basing of asset values will be allowed as at 5 April 2019, with the aim that only relevant gains accruing from 6 April 2019 will be subject to the new regime. The re-basing will not in all cases be mandatory, but the flexibility allowed to taxpayers in this regard may not be used to generate an allowable loss for UK tax purposes.
Direct disposals of UK property (which for these purposes would include a disposal which is effected through a tax-transparent vehicle such as a partnership) will be entirely within the rules, so that 100% of any relevant gain on the non-UK tax resident’s interest in the relevant UK property is subject to UK tax. Depending on the tax profile of the non-UK tax resident investor, reliefs such as writing-down allowances and funding costs may be available to reduce the taxable gain. For corporate investors, the applicable rate of tax is currently anticipated to be 19% (falling to 17% in April 2020). Persons who are currently exempt from tax on the disposal of UK property (other than by reason of tax residence) are not intended to be brought into the charge to UK tax by the NRG Rules, although as discussed below, they may (subject to the outcome of the UK Government’s further consultation) suffer the economic effects of the tax where their investment is made through tax-opaque non-UK tax resident holding vehicles.
Where there is an indirect disposal (i.e. the non-UK tax resident disposes of its interest in an asset, such as a company, which itself derives value from the UK property), then two further tests determine whether any gain is within the charge to UK tax: the company which is disposed of must derive at least 75% of its value from UK property (this is a multi-part test which traces economic and legal interests through multiple tiers of holding); and the non-UK tax resident must hold (or have held, within the two years preceding the disposal) a “25% investment” in the company.
In relation to the 25% investment test, shares and other stock, as well as “non-commercial loans”, may be taken into account. Interests held by connected parties (such as companies within the same group or, in the case of individuals, certain members of the same family) may be aggregated. Importantly, the interests of partners in a partnership will not automatically be aggregated, although the usefulness of this concession will need to be considered in the light of the treatment of property funds and joint ventures generally, when known.
As noted above, the UK Government acknowledges (and marks for further exploration in consultation) the complexity of joint venture and fund holdings (referred to as “collective investment vehicles” or “CIVs”) of direct and indirect interests in UK property. Certain important concessions from the position initially stated in the Q4 2017 consultation are apparent, such as (a) an exemption from the charge on indirect disposals where the relevant property from which the value of the company is derived is used for the purposes of a trade and (b) a proposal, under consultation, to allow widely held offshore funds to elect into a special tax status which would exempt gains made “within the fund structure” from the charge, and tax instead only the investors on the disposal of interests in the fund (this latter proposal being at the cost of the fund providing detailed reporting to the UK Government on investors, values and disposals). Further options for the potential treatment of offshore funds (including elective tax-transparency) are under continued consultation, and this is an area which will merit close attention, particularly for tax-exempt investors who might otherwise suffer the economic effects of the tax where their holding is structured through a taxopaque non-UK tax resident vehicle which itself disposes of a direct or indirect interest in UK property.
The draft legislation now in circulation addresses not only the measures outlined above (and related subsidiary matters), but also seeks to align the UK’s existing rules on the taxation of persons holding interests in UK residential property through non-UK tax resident “envelopes” with these rules. The UK Government is also taking this opportunity to re-write (although with a stated aim of not changing existing law) some of the basic mechanisms of UK tax on chargeable gains. As such, and given the acknowledged uncertainties in the NRG Rules referred to above, we can expect significant further discussion of, and perhaps amendment to, the legislation as it moves towards publication in the 2018 budget (expected in Q3) and enactment as part of the Finance Act 2019 (expected in Q1 2019). Although the fundamentals of the charging provisions are unlikely to change, there is considerable detail, particularly in relation to the application of the rules to CIVs and joint ventures, to be worked out, and we will continue to monitor future developments.