On 20 March 2017, HM Treasury and HM Revenue & Customs published a consultation on bringing non-UK resident companies with UK source rental income within the scope of UK corporation tax. The consultation also considers the case for bringing the disposal of UK residential property held by non-UK resident companies within the corporation tax regime. Therefore, the consultation is relevant to non-UK resident companies that receive rental income from UK property and those which are currently within the scope of Non-Resident Capital Gains Tax (“NRCGT”).
This is early days in the process and the government will publish its response to the consultation in the autumn. It is possible that any legislation implementing the provisions will apply from 6 April 2018.
What is crucially important (and will be very welcome) for investors in UK commercial property is that the government’s intention does not include bringing non-UK resident companies holding UK commercial property into the scope of corporation tax on gains arising on a disposal. This is however starting to look a little vulnerable.
Taxation of UK real estate: The changed and changing landscape
In the last few years the landscape for the taxation of companies that own UK real estate has dramatically changed. In April 2013, the punitive SDLT provisions for companies (and certain other entities) acquiring high value residential property were introduced alongside the annual tax on enveloped dwellings (“ATED”) and ATED related capital gains tax. In April 2015, gains arising on the disposal of UK residential property held by certain non-resident companies became chargeable to NRCGT and from July 2016, legislation was introduced to bring non-UK resident companies which carry on a trade of dealing in or developing UK land into the corporation tax regime regardless of whether the company has a UK permanent establishment.
The rationale for the current consultation is to ensure that there is consistency of treatment between UK companies and non-UK companies in particular with the introduction of the new corporate interest restriction and the new rules for the carry forward and surrender of losses, which are likely to have effect from 1 April 2017 (although see below). This would be a fundamental change to the taxation of the majority of non-UK companies which are currently paying income tax on UK rental income and file self-assessment returns.
Both the corporate interest restriction and the reform of corporation tax loss relief were dropped from the Finance Act 2017 as a result of the calling of the general election but it is likely that both measures will be introduced in a subsequent Finance Act which will be passed after the general election. It is not yet known whether the original implementation date of 1 April 2017 will be retained in that case.
Computing UK property business profits
If the profits of a UK property business are brought within the charge to corporation tax, the following will be relevant:
- The computations of the profits of the UK property business would change such that the UK corporation tax rules apply to determine the tax liability. Most significantly, this will affect the way finance costs (e.g. interest) are deducted and the availability of group relief.
- The new (draft) corporation tax loss rules are likely to apply which means that only 50% of the profits in an accounting period can be sheltered by carried forward corporation tax losses (subject to an annual allowance per group of £5 million of profits which can be relieved in full). Also, carried forward losses made by the non-UK resident company could be surrendered to other group companies which are within the charge to UK corporation tax.
- The new corporation tax interest restriction is likely to apply. The new (draft) rules provide a de-minimis exemption of £2 million for interest costs (on a group wide basis and if there is no group, the relevant company would be entitled to the £2 million exemption in its entirety). For interest expenses in excess of this amount, the full amount of the expense would not be allowable against the profits if it exceeds 30% of “tax-EBITDA”.
- Gains on a sale of residential property which would currently be subject to NRCGT will become chargeable to corporation tax.
There would also need to be some transitional provisions to cover the transition from income tax to corporation tax which are likely to include:
- The first corporation tax accounting period would start on the 6 April of the relevant financial year (which could potentially be 6 April 2018). There would be a deemed cessation of the UK property business as at 5 April for the purposes of the charge to income tax.
- Any unused losses from the UK property rental business treated as ceasing on 5 April should be capable of being carried forward as “income tax property losses” and these losses could be grandfathered and could be carried forward against future profits of the UK property business but would not be able to be surrendered as group relief or set off against other corporation tax profits of the non-UK resident company.
- The income tax property losses could be carried forward to subsequent accounting periods and those losses could be set off against future profits of the UK property business without restriction.
The consultation remains silent on the Non-Resident Landlord Scheme (“NRLS”) although the consultation does say that there are no plans to alter the status quo of the withholding regime for the deduction of tax at source. So it is currently thought that the NRLS would remain in place and a tenant wouldn’t be able to pay amounts of rent to a non-resident landlord until it has received approval from HMRC but there would need to be a transitioning of the NRLS rules to corporation tax.
To the extent that the changes are implemented in a form or similar form as set out in the consultation document, some non-UK resident companies may be in a better position as a result of such changes. The corporation tax rate is currently 19% (and will be decreasing to 17% by 2020) which is lower than the 20% basic rate of income tax which currently applies and the 20% rate of NRCGT. Also, for non-resident companies which are part of a group, the ability to surrender losses to other group companies to reduce their tax liabilities may be beneficial.
However, for large companies with higher borrowings there is the possibility that some of the interest expense may not be allowable therefore creating an additional tax cost.
For investors in commercial property, there will still be attractive reasons for holding UK property through a non-UK resident company because the gains on the sale will remain outside of the UK corporation tax net.
It is early days for the proposal but the government will provide further details in its response in the autumn with perhaps the introduction of the new rules from 6 April 2018. Clearly, non-UK resident companies owning UK real estate need to be aware of the impact that these rules may have.
The consultation document can be viewed here.