UK- NEW LEGISLATION ON TAXATION OF OFFSHORE COMPANIES WHICH OWN UK PROPERTY

In May last year the consultation document entitled “Ensuring fair taxation of residential property transactions” was published. 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 11th December 2012 outlining the new taxes and charges which will have to be paid by offshore companies which own property in the UK worth over £ 2 Million. There were some significant changes from the consultation paper. Next, the actual legislation was included in the Finance Bill 2013 and again showed changes from the draft not least in the name of the new annual charge.

The main features of the legislation will only affect properties which either are, or will become, valued at more than £2 million and which are owned by “non-natural persons” - this being a reference to companies, partnerships, funds and the like, not to persons with strange personal habits.
Previously many buyers of UK property chose 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. If a company owns the property 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 pay IHT on the shares. 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 allowed the purchaser to avoid SDLT and/or allowed the seller to charge more, or a bit of both.
 
Offshore companies which own property worth over £2 million will now be faced with an annual charge of a minimum of £15,000 and a maximum of £140,000 depending on value. The new tax was to be called the Annual Residential Property Tax (ARPT). In the legislation it was called the Annual Tax on Enveloped Dwellings (AETD). I wonder which committee came up with that one? The companies will also pay 28% Capital Gains Tax (CGT) on resale.

Corporate trustees are not subject to these new taxes. 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. Those who have purchased property purely as a buy to let investment may well be able to rely on this and ignore the new legislation. Those who do, or may, live in their property will be effected.

The best structure going forward will depend on a variety of factors including the tax residency and domicile of the owners and any intended beneficiaries of the trust or even occupiers of the property but let us consider the example of Mr Guiseppe Sixpack (GS) an Italian resident and domiciled individual who intends to move to the UK during the current tax year (i.e. between 6 April 2013 and 5 April 2014). GS, through an offshore company, holds the freehold of a residential property in London which he will live in. The property was acquired in November 2001 for £1,400,000 and is currently valued at £4,000,000. It is not currently rented out and there is no mortgage.

As the property was beneficially owned by a company on 1 April 2013, the company will be subject to ATED (1). The property’s value as at 1 April 2012 will determine the liability to ATED (2). The Company is currently liable to pay a charge of £15,000. The first chargeable period runs from 1 April 2013 to 31 March 2014. The Company must file a return for the first chargeable period by 1 October 2013 and pay the charge by 31 October 2013 (3). This is a transitional measure and the return for the second chargeable period, commencing 1 April 2014, must be filed by 30 April 2014. The tax for the second chargeable period must be also paid by that date. The property will need to be re-valued on 1 April 2017 to cover the ATED returns for the five years starting on 1 April 2018. However until 30 April 2018 the charge should be limited to £15,000 payable by the 30 April each year. To correctly calculate the charge the property must be independently valued by a professional such as a chartered surveyor.
  
It is possible for a company to obtain relief where it does not hold the property throughout the whole chargeable period. This is known as interim relief and must be claimed (4). Broadly, the charge is reduced to reflect the number of days in the chargeable during which the property was not held in the company (5). For example if the property were to be sold to a third party individual on 30 September 2013, the seller Company could reclaim 50% of the original charge (6). The precise procedure for claiming the relief and the contents of the ATED Return will be fleshed out by HMRC in supplementary Regulations to be published in the summer.
 
Capital Gains Tax (CGT)

The legislation provides that a company which holds a property on 1 April 2013 that is within the scope of the ATED charge is deemed to have acquired the property for its market value on 5 April 2013 (7).
 
The property was acquired in November 2001 for £1,400,000 and it is assumed that it had a value of £4m on 5 April 2013.

Shadow Directorship issues

If GS were to occupy the property in the future rent free there is a danger that he would be subject to an annual benefit in kind tax charge as he would be treated as a shadow director. The case of Dimsey v Alan established that the benefit in kind provisions do extend to shadow directors.

For these three reasons, it is likely to be more tax efficient to consider moving the property out of the Company. Mr GS has a number of options to mitigate the applicable taxes.

If the property were gifted to GS there would be no SDLT as there is no mortgage. There should be no charge lifetime IHT (8) as the asset would still form part of the beneficial owner’s estate. However there would be CGT to pay- if the property at the time of value was worth more than the £4,000,000 April 2013 value. Here there is a nasty trap. If GS was resident when the company sells the property the whole of the gain since acquisition could be attributed to him under s 13 TCGA 1992
Advantages of individual ownership

1. There would be no ATED charge from 6 April 2014 onwards provided the transfer was made to the individual before that date.
2. There would be no UK CGT on a future disposal provided GS used the property as his main residence throughout the entire period of his ownership (9).
3. There would be no shadow director issues which can arise with corporate ownership.

Disadvantages

1. The property would be subject to UK IHT of 40% on GS’s death.
2. The ability to mitigate the charge with debt or even bank finance has been severely restricted (10).

Option 2: Share Sale to a new Dry Trust
This plan would involve GS’s family member establishing a new dry trust (i.e. a single asset holding trust) with a nominal cash sum. GS would sell the Company shares to that trust. The consideration would be a loan note equal to the market value of the property on the date of the share transfer. The Company would be liquidated by the trust. The liquidation would not cause a SDLT issue as there is no mortgage.
Advantages

1. The property would be outside the charge to UK IHT.
2. There would be no CGT on a future sale by the trustees.
3. There would be no ATED from 1 April 2014.

Disadvantages

1. There is a ten yearly charge of up to 6% on the net asset value of the trust’s UK assets. However the charge should be mitigated by the value of the loan the trust owes to GS on the tenth anniversary (11).
2. The trust would need to avoid selling the property, thereby realising a potential gain, when GS is UK resident. Otherwise GS would be subject to UK CGT to the extent that the value of his rent free occupation could be matched with the gain made by the trust on the sale. The liability would be significant but can be avoided provided GS is not UK resident in the tax year of the disposal and is not caught by the 5 year rule noted above.

Non UK domiciled purchasers should henceforth use a similar trust structure to the above. Domiciled purchasers should consider purchasing via a QNUPS structure.
From the above it will be apparent that is a highly technical area and expert advice is, as always, strongly advised.
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.

1. Refer to Part 3 of the Finance Bill 2013
2. FB 2013, Section 99(2)(b)
3. Refer to the FB 2013, Schedule 33, Part 2, para 4.
4. FB, s97
5. FB s158(4) sets out the procedure for making the interim relief claim
6. This must be paid by 31 October 2013.
7. The FB has inserted a new CGT code into TCGA 1992 to account for ATED related gains. The calculation of the base cost is found in the new Schedule 4ZZA in TCGA. Refer to paragraph 3(2).
8. Under IHTA 1984, s 94
9. Under TCGA 1992, S10A
10. It has inserted a new s175A IHTA 1984 which severely restricts the deductibility of debt on death
11. This position needs to be carefully watched. It is possible that the debt may not be deductible under s.162A which is to be inserted into IHTA by the Finance Act. As yet it appears section 162A would not deny a deduction but it may be subject to further amendments before it hits the statute books.

Offshore companies owning UK residential property need to take urgent action

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 teas "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, scene 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 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 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 tea 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 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 wit 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.