Over the past few years the UK government has made significant changes to the taxation of UK residential property.
In particular, companies and non-UK persons holding UK residential property have been faced with new and increased taxes on purchase, disposal and the period in between. With new legislation seemingly introduced biannually, those owning and thinking of purchasing UK residential property need to consider their tax position more carefully than ever.
Charles Russell Speechlys has expertise in handling matters with a cross-border dimension and strong links to various regions that are popular with overseas investors in the UK property market, including the Middle East. Whether you currently hold UK property and would like to review the ownership arrangements or are considering investing in the market, we can advise on the relevant tax and estate planning issues. This briefing note sets out a general overview of the key UK taxes on let UK residential property, but clients should take detailed and tailored advice before commencing any transactions.
INHERITANCE TAX (IHT)
For UK domiciled or deemed domiciled individuals, worldwide assets above the nil rate band (currently £325,000) will be taxed at 40% on death. For non-UK domiciled individuals who are not deemed domiciled, only UK assets above the nil rate band will be taxed at 40% on death. This includes UK assets that have been given away in the seven years prior to death (although the rate of tax reduces from three years after the gift) and UK assets from which the donor continues to enjoy a benefit.
Currently, holding UK real estate through a non-UK company can offer IHT protection for non-UK domiciled individuals, as the asset held by the individual (i.e. shares in the non-UK company) will be non-UK. However, it has been announced that from April 2017 such holding structures will become “transparent” and the ultimate owner will be treated as owning a UK asset directly for IHT purposes. It is highly likely that this change will be enacted, although it is possible that the effective date of the change will be later than April 2017, as the legislative timetable has been affected by the UK’s referendum vote to leave the European Union. This prospective change means that there is not much scope for sheltering existing properties from IHT.
UK assets (including, from the date of introduction of the IHT “transparency” rule, UK residential property held via a non-UK company) which are put into trust will be subject to an up-front tax charge at an effective rate of 25% on their value above the nil rate band, and will then be subject to a 6% charge every ten years and on exit from the trust. In addition, any such assets will usually also remain within the settlor’s estate for IHT purposes (i.e. exposed to a 40% IHT charge on death).
ANNUAL TAX ON ENVELOPED DWELLINGS (ATED)
ATED is an annual tax on high value residential property owned through non-natural persons (broadly, companies) which now applies (subject to exemptions) to all properties worth £500,000 or more. Where applicable, the annual charges for the current year range between £3,500 and £218,200, depending on the value of the property.
There are a number of exemptions from the ATED regime, including one for let properties. Various conditions must be met to qualify for the exemption, but it broadly applies where a property is let to a third party on a commercial basis, with a view to profit. The exemption may still be available during periods of non-occupation, provided the owner is taking sufficient steps to rent the property out. However, if the property is occupied by or let to a person connected with the owner of the property (this is a fairly wide class of people), the exemption will be lost.
Where a property is in principle within the scope of ATED but an exemption applies, ATED returns must be submitted to HMRC to claim the exemption. Exemptions are only available if claimed.
CAPITAL GAINS TAX (CGT)
UK resident individuals are subject to CGT on all gains realised on disposals of property, typically at a rate of 28% (depending on the individual’s other income and gains). A 100% relief is available for a gain realised on the disposal of a main residence, provided that certain conditions are met. Disposals included gifts as well as sales.
UK companies are subject to corporation tax (currently 20%), rather than CGT, on gains realised on disposals of property. However, where the property is subject to ATED, (broadly) the post-5 April 2013 element of the gain will be taxed to CGT at 28%, instead of corporation tax.
Since 2013, CGT on UK residential property has been introduced in stages for non-UK residents (individuals and companies). A 100% relief is available for a main residence held by an individual, but this will only apply in limited circumstances (and never where the holder of the property is a company). The calculation of this CGT charge is complex, but broadly CGT will only apply to the post-5 April 2015 element of the gain (or typically the post-5 April 2013 gain for properties subject to ATED), so that there is effectively a “rebasing” of the properties to their values at this date. Generally, the applicable rate of such CGT charge is 28%, but the rate of tax for a non-UK company disposing of let property which has been exempted from ATED is 20%.
STAMP DUTY LAND TAX (SDLT)
SDLT of up to 15% is payable by a purchaser of UK real estate. It can also apply when a person transfers an existing property that is subject to a mortgage or on a transfer, even for no consideration, to a closely held company.
The SDLT rate will depend on a variety of factors, including: the value of the property, the property use (i.e. residential or commercial), the number of properties included in the transaction and whether or not the purchaser is a natural person.
For an individual purchaser of UK residential property, the basic SDLT charge can reach 12%, depending on value. However, since 1 April 2016, purchasers of additional residential properties have been liable to pay a 3% surcharge on top of the basic SDLT charge; this additional charge catches second homes and buy-to-let properties.
“Multiple dwellings relief” can be claimed where more than one residential property is purchased in a single transaction or in “linked transactions” (i.e. transactions which form part of a single deal). Under this relief, the rate of SDLT applicable to each property is calculated by reference to the average purchase price of the properties, rather than the aggregate of the purchase prices. This relief is subject always to a minimum SDLT rate of 1%.
An alternative relief is available where six or more separate residential properties are the subject of a single transaction. In this case, such properties will usually be subject to SDLT at the (lower) commercial property rates, i.e. currently at a maximum of 5%. However, this relief cannot be claimed together with multiple dwellings relief on the same transaction.
UK residents are subject to UK income tax on UK rental income in the same way as other types of income. The Non-Resident Landlords Scheme (NRLS) ensures that non-UK residents are also fully taxed on UK rental income.
Under the NRLS, letting agents must deduct the basic rate of tax (20%) from the rental income at source and pay such tax to HMRC. Where there is no letting agent, tenants must deduct and pay the basic rate tax, unless they pay rent of not more than £100 a week.
Alternatively, non-UK resident landlords may register with HMRC to receive the rent gross, provided they meet one of a number of conditions, e.g. that their UK tax affairs are up to date. They are then required to complete UK tax returns and pay the tax due each year. The benefit of registering is the ability to deduct relevant expenses which they have paid (i.e. rather than just expenses which the letting agent/tenant has paid) from the gross rent received, when calculating the rental profit that is subject to income tax.
Currently, interest paid on loans to buy or improve property is fully deductible from rental income when calculating the taxable rental profit. However, for individual landlords, this relief is due to be limited in future to the 20% basic tax rate (i.e. such that only 20% of the loan interest is deductible), with a phased introduction from 2017 to 2020. This restricted relief will not apply to corporate owners of residential property, commercial property or furnished holiday lettings.