UK PUBLISHES DRAFT LEGISLATION ON OFFSHORE COMPANIES WHICH OWN UK PROPERTY

The consultation document entitled “Ensuring fair taxation of residential property transactions” was published in May this year. As always whenever the UK Treasury or HMRC refer to “fair taxation” what they really mean is “considerably increased taxation”. The resulting draft legislation was published on 11^th December outlining the new taxes and charges which will have to be paid by offshore companies which own property in the UK.  There have been some significant changes from the consultation paper.   There is still a small chance that there will be alterations before the enactment of the actual legislation in April next year but no further surprises are expected and it would be unusual if there were any more changes. Property owners should plan accordingly.

The main features of the proposed legislation will affect properties which either are, or will become,  valued at more than £2 million and which are owned by “non-natural persons”.  This is a reference to companies, partnerships, funds and the like, not to persons with strange personal habits.

Previously many buyers of UK property have chosen to register their properties in the name of an offshore company in order to eradicate UK inheritance tax (IHT) which would otherwise be charged at 40% on the whole value of the property , after allowances, upon the death of the owner.  As a company never dies the asset becomes the shares of the company which is a non UK asset and therefore not subject to UK IHT as long as the owner is not UK domiciled. Owners who are UK domiciled are subject to IHT on their worldwide assets so the tax catches the whole estate. Many UK expatriates will remain UK domiciled despite living abroad for many years. Offshore company ownership also facilitated the avoidance of stamp duty (SDLT) as any subsequent sale of the property could be effected by a transfer of the shares in the company leaving title to the property in the UK unaltered.  This would mean the incoming purchaser avoided SDLT and allowed the seller to charge more or made it easier to sell as it was cheaper for the buyer, or a bit of both.   

Offshore companies which own property worth over £2 million will now be faced with:

1.       An annual charge of a minimum of £15,000 and a maximum of £140,000 depending on value. The new tax is called Annual Residential Property Tax (ARPT).

 

2.       Capital Gains Tax (CGT), which was previously not paid by non UK resident sellers whether they were individuals or companies, will be charged on resale at a rate of 28%.

New offshore company purchasers will pay stamp duty at 15% whereas natural persons will pay stamp duty at the bargain rate of only 7%.

A transfer of property to an individual or individuals (presumably the beneficial owner or owners of the company) who own the company will avoid these charges but expose those individuals to UK inheritance tax at 40% so this is an option which will appeal only to the very young and very healthy who are quite certain of their own longevity.  For those less certain of their own mortality this will not be a sensible option.  It is possible to cover the liability by life insurance but actuaries have of solvent life insurance companies have got it right. You will pay more than you receive so this is an expensive option which normally appeals most to life insurance salesmen.

The good news is that there are exemptions from the above taxes.  The main one of these is that corporate trustees are not subject to these new taxes. For most, transferring property already owned by an offshore company to an offshore trust will be the most cost effective way forward. For new purchasers making the purchase via an offshore trust will be best.  There is also an exemption for bona fide business assets owned by companies. This would apply where the property is rented out exclusively and entirely to third parties. The problem here is that even a single day of occupation by anyone connected with the company at any time when that company owned the property would cause the exemption to be lost so this is somewhat inflexible and inherently risky.

Luckily, there has been one change to the original proposals. CGT will be based upon the difference between the sale price and the presumed value at April 2013.  Originally the CGT was to be based upon the original acquisition value and resale price.  This is obviously an improvement for those who purchased a long time ago and have seen the value of their investment rise considerably. Even those who have bought unwisely will have made a big paper profit so this is welcome news but would not seem to make much difference to the correct structure going forward. 

Trustees who hold UK assets are subject to the ten year anniversary charge which could be as much as 6% of the value of the property but this charge is only made on the equity on the property.  The equity on the property is the difference between the property value and any loans against the property.  It is therefore recommended that the properties be laden with debt whether that be loans from a bank or from loans injected by the Settlor or other persons associated with the trust.

Between now and April 2013, properties can still be transferred to a new structure without CGT applying.  After April any changes in ownership are likely to result in tax consequences and the annual charge will start biting.  In summary, there is a brief window when action can be taken at minimal cost to avoid future CGT and ARPT so urgent action is required.  Prevarication or inaction is likely to result in significant additional costs.

Howard Bilton is a UK and Gibraltar barrister, Professor of Law at Thomas Jefferson School of Law, San Diego and Chairman of The Sovereign Group.

Companies owning UK residential property need to take urgent action

Earlier this year the UK Government announced far-reaching proposals to change the way that non UK companies which owned UK residential property would be taxed. Previously these companies, like non UK resident individuals, had not been liable to pay Capital Gains Tax (CGT). Under the new proposals this would change and those companies would now be subject to CGT, broadly calculated on the difference between the acquisition value and the disposal value. There are many companies who acquired UK property many years ago so their base value for CGT purposes will be very low. On resale of the property those companies are going to face a very heavy tax bill.

Additionally, companies which own a property worth more than £2 million will now be subject to an annual tax which is being referred to as “Mansion Tax”. The amount will vary according to value but will be a minimum of £15,000 and a maximum of £140,000.

These charges are going to greatly impact on the investment value of such properties. Both charges can be avoided by transferring the property from the company to individual owners but, particularly for older buyers or those in poor health, that will not be attractive as it will mean that the property is subject to UK Inheritance Tax (IHT) at 40% of the total value if anything happens to the owner. Obviously it won’t concern the owner themselves as the charge will only be triggered when they are past caring but many will be concerned to try and preserve wealth for the benefit of their family and heirs. For that reason, individual ownership will only seem interesting if the ultimate owners are young and/or intending to sell the property sooner rather than later. Those owners are likely to be in the minority. Insurance is likely to be an alternative way of covering the IHT but is likely to be expensive especially for older owners. HMRC did announce some exemptions from the new charges. More detail of those exemptions have now emerged so the planning opportunities have now become clearer.

The first exemption announced was that professional trustees holding residential property would not be subject to the new 15% rate of Stamp Duty Land Tax (SDLT) that was introduced in April this year. They will also be exempt from the Mansion Tax but there is no general exemption from the new CGT charge which previously did not apply to non UK residents. Exemption from CGT can be obtained if the trustees and a beneficiary occupying the property both claimed Principal Private Residency relief. This would normally apply where the property is occupied by any beneficiary or any number of different beneficiaries of the trust. CGT might also be avoided by “selling” the property by changing the beneficiaries of the trust or if the trustee was a private trust company by changing the ownership of the trustee or by both. In fact there appear to be so many potential ways to avoid CGT and so many difficulties in collection that the latest rumour is that HMRC may decide not to introduce this new extension. At this stage it would be unwise to assume that CGT will not apply.

Discretionary trusts are subject to a ten yearly charge which could be as much as 6% of the capital value of the property. This is an attempt by HMRC to claw back some of the 40% IHT which is lost if UK property is held within trust. The way the ten year anniversary charge is calculated is complicated so 6% is certainly the maximum but it will generally work out to be between 3% and 6% depending on value and other circumstances. Luckily this charge is only payable on the equity in the property. If loans are used to purchase the property, the tax is payable only on the difference between the capital value and the loan amounts. For this reason it seems as though a two trust structure may give the best of all worlds. One trust, set up by a non-UK domiciled person, can receive the capital amount needed to purchase the property. That amount is then loaned to another trust which actually buys the property. The loan amount is then deducted from the value of the property for the purposes of calculating the 10 year tax. The loan could be sufficiently large to reduce the tax to a nominal or zero amount.

The above does not work for those who are still domiciled in the UK because the transfer into trust would trigger the lifetime IHT charge of 20%. For UK domiciled persons it is better to use a Qualifying Non UK Registered Pension Scheme (QNUPS). A QNUPS is a pension trust that enjoys special UK IHT treatment. The pension trustees (typically corporate trustees) are exempt from the new 15% SDLT charge and from the Mansion Tax. A QNUPS is not subject to the ten year anniversary charge. The terms and conditions necessary for the trust to qualify as a QNUPS do mean that access to the capital is somewhat restricted. The property can be sold and the money can be re-invested in another property or anything else allowed for under the pension rules but the pension holder would only be able to take the money out of the QNUPS according to the rules of the scheme. Those rules normally allow the pensioner to take a lump sum out on retirement and then the rest in drawdown. That restriction may not suit everybody so the trust structure will be preferable for non doms. Happily, a gift by a non UK company to either a trust or a QNUPS can be made free of SDLT as long as there is no mortgage in place on the property. If there is a mortgage then SDLT is payable on the mortgage amount so the transfer could prove expensive to do now but will result in large savings in the future.

Trusts owning residential property are subject to higher rates of tax on rental income. They pay up to 50%. To reduce the tax on income the income rights can be vested in an offshore company wholly owned by the trust when the property is acquired. The tax rate is then reduced to 20%.

Anybody who owns UK property worth £2 million or which may become worth £2 million in the future should take action now. There is a window of opportunity to rebase the capital cost as long as this is done before April next year.