CAPITAL letters - Issue 33

Despite these changes, we still believe in the UK property market – our property law is strong and stable (I'm channelling Theresa May here) and a lack of supply will tend to hold up prices. Accordingly, in order to provide a full service to our private clients, we have carved out, from our wider real estate practice, a dedicated high-value residential property team, which comprises of partner Archie Campbell, managing associate Patrick Lundie and associates Fiona Li, Alicia Morgan and Gideon Caplin. They often work alongside partner Navpreet Atwal and managing associate Richard Pike in our construction team who are experts on residential refurbishment and construction work.

Click here to read our team's guide to buying high-value English residential property.

Capital Gains Tax

As a quick reminder there are now three significant dates for non-resident company landlords. The first is the non-resident CGT (‘NRCGT’) start date of 5 April 2015 for UK residential property, with a rate of 28% for gains after that date. The second date is 5 April 2019, when NRCGT was extended to all UK property, including commercial property. Once again, the tax only applies from the commencement date, meaning you get a re-base on that date. At the same time, "ATED related CGT" was abolished, meaning the earlier relevant date of 5 April 2013 is no longer relevant.

For corporate landlords the tax rate for commercial property from April 2019 was 19%, as this reflected the Corporation Tax (CT) rate at that time, although non-resident companies were not then subjected to the full CT regime. However, following the introduction of CT for non-resident companies from 6 April 2020, which is our third significant date, those companies are subjected to the full CT regime, on which more below.

This also meant that the NRCGT (paper) forms were no longer required for companies from April 2019 onwards. Instead, non-resident companies must file online in accordance with the full HMRC protocols for CT. Believe me, that's no fun at all.

NRCGT forms still need to be completed and filed, and any tax due paid, by trustees and individuals within 60 days of any gain being realised. This is an improvement on the previous 30-day timescale which applied until 2021.

Inheritance Tax

After the introduction of ATED in 2013, despite the additional tax burden this created, many non-domiciled owners opted to keep properties in their offshore corporate wrappers as the company shares were excluded property for IHT purposes.

However, this changed in April 2017 with the IHT anti-enveloping legislation. Excluded property status was removed from certain non-UK assets whose value is related to UK residential property. Shares in close companies owning UK residential property and loans to fund the purchase or maintenance of UK residential property are no longer excluded property, prompting owners to look again at the viability of using offshore companies to hold UK property.

ATED: is it finally time to de-envelope?

ATED broadly applies where a company (UK or offshore) owns UK residential property worth more than £500,000 unless a relief applies, such as renting to a third party. The tax is payable annually on sliding scale depending on the value of the property. The charge for 2023/24 for properties worth more than £500,000 up to £1 million is £4,150. Properties in the £2 million up to £5 million bracket will pay £28,650 and at the top end of the scale (£20m +) the charge is an eye-watering £269,450. The rates are increased each year in line with the Consumer Price Index.

No one really wants to pay this tax – especially since the IHT benefits have been removed - so it makes sense to remove properties from companies, at least where the owner (or an associated person) is in occupation. However, this isn’t easy as there are potential CGT and SDLT charges if you do so.

SDLT can generally be avoided if there is no debt against the property in question, but CGT is a bigger challenge. As noted above, since 2015 there has been CGT on non-resident owners of UK residential property, so any attempt to remove a property from a company (for instance by way of a dividend or upon liquidation) is potentially chargeable. Furthermore, if the owner of the offshore company is UK resident, then there is a potential double charge to CGT on the same gain (I could tell you why, but we don’t have time).

However, if your property is in Prime Central London there is an opportunity to de-envelope, as prices have been pretty static since 2015, due to the sky-high SDLT charges introduced a few years ago. Given that your base cost for CGT purposes is the value as of April 2015, you may find that the gain is marginal – thereby enabling you to de-envelope with little tax cost.

Extension of CT to non-resident companies

From 6 April 2020 all non-resident companies became liable to CT on both their UK income and gains from UK property which had major implications for offshore companies and the people that run them. Up until 2020 non-resident companies were charged to UK Income Tax on UK rental profits, but now they will be charged to CT. Initially there was a margin of good news as the rate of tax reduced to 19%, whereas the income tax rate was 20%. However, the main rate of CT is now 25% (from 1 April 2023) so that good news has evaporated.

Further (bad) news is that the calculation of profits must be made in accordance with the CT rules, which are much more complex than the Income Tax rules and they contain some nasty additional surprises, such the Corporate Interest Restriction and loss carry forward rules.

The Corporate Interest Restriction (CIR)

Where it applies, the CIR is an ugly beast as it limits your deduction for CT purposes on financing costs to 30% of the turnover. Whilst this only applies to companies or groups of companies where the financing costs exceed £2 million per annum, there are a number of other provisions which may affect corporate landlords with lower borrowing costs. For instance, the ‘unallowable purpose rules’ affect loan relationships which are created for tax avoidance purposes. This is particularly relevant to offshore property holding structures, which are often entirely constructed to mitigate tax.

Loss relief

The loss relief rules for CT differ from those applicable to Income Tax and will be an issue for non-resident companies with large carried forward losses (that is over £5m). Where caught you will be restricted to carrying forward only 50% of your losses.

Loan Financing and Withholding Tax

Offshore holding structures are already impacted by new loan relationship rules (see above) but the latest case on UK source interest - Hargreaves Property Holdings Limited v HMRC[2023] UKUT 120 (TCC) – is another blow for offshore corporate landlords.

Many offshore corporate groups use internal debt to finance UK property acquisitions. Essentially, one group (or associated) company lends to another, with the latter claiming a tax deduction for the interest payable. In such cases it was thought that the interest was not UK source – since neither the lender or the borrower were situated in the UK and no charge was taken over any UK property. If it's not UK source then there is no withholding tax – meaning that that you get a tax deduction for interest paid, but with no corresponding liability to UK tax on the interest received. This was probably always too good to be true, but until the case of Ardmore Construction Limited v HMRC [2018] EWCA 1438 it was generally thought to work. This case established that you need to take a wider view of whether something is UK source or not and where a borrower is essentially financing its interest payments from UK rents then, unsurprisingly, the interest should be considered UK source.

The Hargreaves case confirms that position and it is now clear that the Tribunal will look at substance over form when it comes to offshore financing where there is a UK asset, even where there is no charge over that asset. The implication of this case is that the offshore borrower will have to deduct 20% withholding tax from any interest payments made to the lender, effectively rendering the offshore finance 'trick' obsolete. Accordingly, we strongly recommend that offshore landlords urgently review their group/associated party finance arrangements.