Recent changes to UK tax legislation have led to questions being raised as to whether non-UK residents should always choose to acquire commercial property in non-UK resident vehicles. It used to be the case that if you were a non-UK resident acquiring UK commercial property, it was generally better to structure the acquisition of such property so it was owned by a company in a non-UK, tax neutral jurisdiction. However, a number of recent developments have meant that this may no longer always be a sensible choice, particularly if there is a plan to develop land and sell it soon afterwards.
Holding property as an investment
If you are investing in commercial property and, broadly, expecting to hold it for at least five years and receive rental income from the property, it is still likely to be sensible to hold the property in a non-UK resident company in a jurisdiction such as Bermuda, the Channel Islands or the BVI.
This is because there will normally be no UK tax on capital gains under current law when an offshore company makes a disposal of the commercial property. However, if, instead, the property is held by a UK resident company, corporation tax would be payable on any gains. Typically, therefore, commercial property held for investment is still held in offshore companies.
If commercial property is being held as an investment, it normally still makes sense for it to be held in a non-UK resident company so that any capital gains are not subject to UK tax.
Trading in property
If you are planning to trade in property, develop new property or renovate an existing holding and then sell it shortly afterwards, the position is no longer so clear cut. New "transactions in land" rules, introduced in relation to disposals on or after 5 July 2016, mean that any gain within these rules will be subject to UK corporation tax, whether the disposal is made by a UK or non-UK resident company.
UK corporation tax rates are now much lower than in the past. The corporation tax rate is 19% at present, and the government currently in power in the UK plans to reduce it to 17% by 2020. These tax rates are reasonably favourable when compared with many other countries.
The distinction between investment and trading
Since for non-UK residents the UK tax treatment if property is held as an investment is currently much more favourable than if property is held for trading/development purposes, it would be helpful if the distinction between these two activities was clear cut. This is not necessarily the case, however, as in order to distinguish between investment and trading/short term development activity, it is necessary to consider UK case law and HMRC's (the UK tax authority) guidance.
UK case law has established that there are certain factors which should be considered known as the “badges of trade” in order to decide whether or not property is held as an investment. These factors include how long the property has been owned, what the intention was when the property was purchased, and whether it has been developed or improved (rather than merely repaired) before disposal.
New “transactions in land” rules
Prior to the new “transactions in land” rules, some property developers would structure their transactions by holding land in a jurisdiction such as the Channel Islands and contend that either profits from the activity were not taxable at all in the UK because there was no permanent establishment in the UK, or that the profit which could be taxed in the UK was limited, since most of the activity from which the profits derived was taking place outside the UK, for example by paying fees to a connected offshore development company. The new rules clamp down on these practices as HMRC want to ensure that onshore and offshore property developers are treated in the same way for UK tax purposes.
The new rules can apply in a number of circumstances including where land is held as trading stock, where it is being developed for the purpose of disposing of it or where one of the main purposes for acquiring the land is to realise a profit or gain from disposing of it. The rules can apply not only where land is sold but also where there is an indirect sale, for example, by selling shares in a company which owns the property.
The new rules are also much broader than the anti-avoidance legislation which previously applied. For example, there are now anti-fragmentation rules which can effectively ignore fees paid to connected persons for services or ignore loans provided in a way which result in a development profit falling outside the scope of UK tax.
Using a UK or non-UK resident company to hold property where the new transactions in land rules may apply
Where it is thought that the new rules may apply, careful thought needs to be given as to whether it is still worthwhile to structure the transaction by holding property in a non-UK resident company since, if caught by the rules, profits will be subject to UK corporation tax in any event. Given the relatively low current UK corporation tax rate it may be simpler to establish a UK resident company.
However, it may still make sense to hold the property through a company based in another country if the investor already has substantial assets in that other country so that it is convenient for the property to be held there and feasible to show that central management and control is taking place there. A UK-incorporated company will normally always be UK tax resident. If a non-UK incorporated company is utilised, it will only be non-UK tax resident if its central management and control (normally where the board of directors meet and make strategic decisions) is outside the UK. Therefore,if a company holding UK property is to remain non-UK resident its affairs must be managed carefully.
There can be some benefits in using a non-UK resident company. For example, UK tax at the basic rate (currently 20%) has to be withheld from interest payments of yearly UK source interest. This obligation will always apply if a UK resident company is making a payment of yearly interest (unless an exemption applies) but will only apply in certain more limited circumstances if interest is paid by a non-UK resident company, so using a non-UK resident company could give greater flexibility. This is a complicated area and specific advice should be sought.
In addition, there may be UK inheritance tax advantages for individuals who are neither domiciled nor deemed domiciled in the UK in holding UK commercial property through a non-UK company.
As described above, companies subject to the new transaction in land rules will now be within the UK's corporation tax system. In contrast non-UK companies holding property for investment purposes pay income tax on rent that they receive. However, there is currently a consultation in the UK as to whether UK corporation tax on income (not gains) should apply to non-UK resident companies in the UK in the same way as it applies to UK resident companies. Principally, this consultation is taking place because HMRC wish to ensure that the new UK corporation tax rules which restrict the deductibility of interest should apply to non-UK resident companies as well as UK resident companies. In addition, they are keen for the new corporation tax loss relief rules to apply to non-UK resident companies as well as UK companies. The implementation of these rules, even for UK companies, has been delayed by the UK's recent general election but it is anticipated that they will come into force for UK resident companies with retrospective effect from April 2017 or soon thereafter.
Although these new rules will not yet apply to non-UK resident companies, the current consultation exercise suggests that this advantage is likely to be short-lived.
This article only considers the position in relation to UK commercial property. There are different factors to be taken into account in deciding the structure through which UK residential property should be held and additional taxes can be incurred if such property is held through companies or certain other vehicles.
If commercial property is being held as an investment, it normally still makes sense for it to be held in a non-UK resident company so that any capital gains are not subject to UK tax. However, where the new transactions in land rules may apply the position is more complex and specific advice should be sought.
Heather Corben, a tax partner with assistance from Howard Gill, a commercial real estate partner who are both at Forsters LLP, a leading London law firm based in Mayfair.
Heather has broad experience of advising corporate and individual non-UK residents and UK residents on the structuring of commercial and residential real estate deals, joint ventures and funds.
Heather can be contacted in the following ways:
Direct Line: +4420 7863 8318
Howard acts for a number of Asian investors who have bought and sold big ticket commercial real estate assets primarily in London.
Howard can be contacted in the following ways:
Direct Line: +4420 7863 8494
The information in this article is of a general nature and does not constitute legal or tax advice. Any person considering a transaction in relation to which this article could be relevant is advised to take their own legal and tax advice based on their own circumstances. The information in this article is believed to be correct as at 9 June 2017. It does not take account of any changes in law or practice after that date.