November’s UK Autumn Budget included an announcement that it is intended, with effect from April 2019, that non-UK resident investors (“NRIs”) should become taxable on gains made on UK real estate, whether residential or commercial in nature.
This is a significant change for the UK, which has not to date taxed NRIs’ gains on UK commercial real estate investments. It may have a significant impact, as recent figures suggest that 87,500 UK properties are owned by NRIs, with 32,000 properties held by Channel Islands entities alone. The reform is subject to a public consultation until February 2018, but it is the details of implementation which are up for discussion, rather than the principles.
It is worth noting that rents from UK real estate are already subject to UK income tax for NRIs, and that NRIs’ gains from residential real estate and from the development of UK real estate are already to some extent subject to UK taxes. But the application of UK taxes to NRIs’ gains on UK property investments represents a significant shift in policy.
The relevant rates of tax are likely to be the rates which UK residents pay (currently 19% for companies (including most property unit trusts) and up to 20% - or 28% for residential property - for others). The proposal would permit commercial property to be rebased for these purposes at April 2019 values. The charge would also apply to disposals by non-residents who hold or have held 25%+ interests in UK property-rich vehicles (proposed to be defined as vehicles deriving 75% or more of their gross asset value from UK real estate) – the “indirect” charge. Some investors would be exempt (e.g. certain overseas pension schemes and sovereigns). It is worth noting that in relation to all these aspects of the proposed rules, the details are yet to be confirmed.
NRIs who benefit from a tax treaty with the UK may be able to get relief under that treaty from the UK tax charge; for example, Luxembourg’s treaty with the UK relieves a Luxembourg resident from the indirect charge on any gain on a UK property-rich vehicle. However, the UK authorities intend to work to amend the relevant treaties, and will introduce an anti-avoidance rule (effective 22 November 2017) to deter NRIs looking to structure into such jurisdictions with an eye on the treaty benefits.
The UK authorities’ intentions here are clear, and for certain categories of NRI the change will raise the unavoidable prospect of UK taxes on gains accruing post April 2019. It seems only realistic to expect that this will have a pricing impact on the UK market to some extent.
Other categories of NRI may be able to consider steps to exempt themselves from the impact of the change, albeit that this will as a practical matter only be likely to be possible where doing so is consistent with the policy of the UK authorities.
For example, NRIs which are exempt pension funds or eligible for sovereign immunity should consider whether existing UK tax-opaque holding structures for UK real estate may now prevent them from benefitting from an exemption on future disposals. It may be permissible to restructure before the change becomes effective in order to keep future gains exempt (although future Stamp Duty Land Tax considerations will also be relevant). Actual implementation of any proposed restructuring is likely best left until the detail of the proposed rules is more certain, however. Such NRIs could also (or alternatively) consider participating in the consultation process to request that their exemption is extended to their UK tax-opaque subsidiary holding vehicles, as a complete exemption where wholly owned, or proportionately for a joint venture. The recent relaxation of the conditions for the availability of the UK’s “substantial shareholding exemption” on disposals by subsidiary companies of such NRIs is helpful here in preventing the indirect charge from impacting on such subsidiaries, and it would seem logical for that approach to be extended to relieve the charge on direct UK real estate disposals by such subsidiaries.
Funds could also consider the possibility of wider utilisation of the UK tax-exempt REIT structure for the purposes of holding UK real estate. In our view it is an open question as to whether it would be contrary to the policy of this reform for a collective investment vehicle to be permitted to use a UK REIT in this manner. We believe it is worth seeking clarification on the point as part of the consultation, in particular to request a clear rule that where a widely held partnership fund disposes of a 25%+ interest in a UK REIT the limited partner investors in the fund should not be subject to the “indirect” charge on gains in respect of an economic share in that REIT of less than 25%.