Whilst the headlines focused on the SDLT exemption for first-time buyers, the Government’s Autumn Budget materials contained proposals for a seismic shift in the taxation of non-residents investing in non-residential property. Over recent years, gradual changes have brought residential property held by non-residents into the CGT net, but until this announcement the commercial property sector, with very different drivers and dynamics, has not been the object of focus.
The consultation, issued on 22 November and running until 16 February 2018, changes this. Although ostensibly a consultation, it is clear that the Government intends, with effect from April 2019, to apply capital gains tax to all forms of property investment by non-residents. This means that commercial property gains will, for the first time, in principle become subject to tax for non-resident investors. In addition, previously applied exclusions from tax on gains on residential property investments, including for widely-held vehicles, will be removed.
Key points of detail already revealed in the consultation include:
- gains realised by non-UK corporate entities will be subject to corporation tax, with effect from 1 April 2019. Gains by individuals will be subject to capital gains tax, with effect from 6 April 2019;
- indirect disposals will also be brought within the charge – i.e. exits via sales of shares or comparable interests – subject to the provisions of any applicable double taxation treaty (certain treaties may limit the capacity of the UK to tax gains on assets deriving their value from UK-situated property). Indirect disposals will be subject to “property richness” and “ownership” conditions that, broadly, will mean CGT will only apply if the entity derives 75% or more of its value from UK property and only then to investors with holdings of 25% or more;
- gains accruing prior to April 2019 will not be subject to tax for both direct and indirect disposals – i.e. there will be “re-basing” of property values to market value at the operative date (with the ability on direct disposals only to elect for historic cost instead if higher);
- anti-forestalling rules will have effect from 22 November 2017 to counteract arrangements implemented with a view to generating a tax advantage by reason of any taxation treaty, where the advantage is contrary to the object and purpose of the treaty;
- non-residents investing in UK property via collective investment vehicles (such as REITs or exempt unit trusts) would become subject to UK tax on their gains, provided the above “property richness” and “ownership” conditions are met; and
- non-resident entities forming part of a UK REIT group would in principle come within the scope of tax on their UK property gains, which will therefore be treated as REIT exempt gains (as opposed to not being taxed by reason of the owner’s residence) – this means that distributions on account of such gains by the REIT will be treated as a property income dividend (“PID“) as opposed to a normal dividend, and hence will be subject to the usual 20% PID withholding tax.
This is a highly signficant change in taxation policy for the real estate sector. The aim on the Government’s part is presumably to remove any remaining reasons for owning UK property offshore and to drive investors to structure asset ownership through UK vehicles (with the reduction in UK corporation tax to 17% from April 2020 playing a part). Although it is typical internationally for the “host” country to tax gains derived from domestic property, the UK has gained significant traction as a destination for offshore capital through a combination of a consistently strong property market and a stable political, legal and fiscal base. It remains to be seen whether this latest and arguably most significant tightening of the taxation net on property investment will dampen the historic appetite for UK commercial real estate.
In the meantime, there remain many points of detail concerning the proposals to be considered and resolved and attention will focus on issues such as the basis of operation of the indirect disposal rules (including the application of the property richness and ownership conditions) and the interaction between the new regime (including the anti-forestalling rules that have effect from 22 November) and treaty provisions.