Chapter 12 - Investing in UK Property:
A Case Study

It is useful to consolidate some of the issues covered in previous chapters and consider a typical scenario, where a UK non-resident and non-domiciled individual wishes to purchase a UK property.

Jack is resident and domiciled in Spain. He has relatives in the UK and is interested in purchasing a property here because (a) he wants somewhere to stay when he visits and (b) he has heard that UK property prices are set to rise.

The question is ... how from a tax perspective should he structure the purchase?

There are broadly two ways to buy the property:

• By using direct ownership, or
• Using some form of intermediary like a trust or company.

12.1 Direct Ownership

Capital Gains Tax

From a capital gains tax perspective direct ownership is potentially attractive:

• The Principal Private Residence (PPR) relief operates to exempt a gain on the disposal of an individual's main residence. Even if the property is not, in fact, Jack's main residence, he could certainly submit an election to have it treated as his main residence.
• As he is non-resident, he would not in any case be liable to UK capital gains tax on the disposal of any assets.

Inheritance Tax

The inheritance tax position is, however, not as good. The holding of property in the UK would mean that Jack has a UK estate and, as well as probate being required on his death, the house would be subject to inheritance tax to the extent that the value exceeds the £325,000 nil rate band. As the value of the property is expected to rise rapidly, this could result in a significant tax bill were he to die while still owning the asset. There are, however, a number of methods available to Jack to reduce or eliminate any inheritance tax charge:

Use of Multiple Ownership

The property could be acquired in multiple ownership. For example, Jack, his wife and children could all own the property jointly.

Provided the individuals have no other UK assets, it is likely that each share will be below the nil rate band.

In order to avoid problems with the 'gift with reservation of benefit' legislation, it is necessary to gift cash to the family members, which they can then use to purchase their shares of the property.

The gift, with reservation of benefit (GROB) provisions, applies to property in particular, where an interest in a property is given away, yet the person gifting the interest still continues to reside in the property. For inheritance tax purposes, the whole value of the property is still regarded as included in the occupier's estate for inheritance tax purposes.

Gifting of Property

Another solution would be to gift cash to a younger member of the family who can then make the acquisition. The gift will be exempt from inheritance tax, provided the person making the gift survives seven years. The above GROB rules would not apply as the gift was a cash gift.

The UK pre-owned assets tax charge should also not be relevant if Jack is non-UK resident.

The property will then belong to the donee (the younger family member) and if the donee were to die, it would be included in his estate for inheritance tax purposes.

Mortgages

The value of an individual's estate is essentially the market value of the assets at the date of death, less any liabilities outstanding at the date of death.

It is therefore possible to effectively reduce any inheritance tax charge to zero by obtaining a substantial loan against the value of the property. Provided the mortgage reduces the 'net value' of the property to below the nil rate band (currently £325,000), there will be no inheritance tax payable.

The mortgage funds obtained can be invested overseas and any interest return would then be exempt from UK income tax provided the interest income is not remitted to the UK.

12.2 Using a Trust to Own the Property

Capital Gains Tax

The Principal Private Residence relief is extended to situations where a beneficiary is entitled to occupy a house under the terms of a trust deed. In these circumstances, the trustees would be able to claim PPR relief when they sell the property.

In the case of a non-UK domiciliary, as the trustees are non-resident they would not, in any case, be liable to UK capital gains tax.

It would only be if the settlor of the trust (or his close family) were also a beneficiary and became UK resident that the gains of the trust could be attributed to him under the anti-avoidance provisions.

Inheritance Tax

The trust will be subject to special inheritance tax rules. One of the key implications is that it could be subject to an inheritance tax charge every 10 years starting with the date of commencement.

12.3 Using an Offshore Company

The property could be owned by a non-resident company. In this case the non-domiciliary would own the shares in the company.

As the shares are non-UK property, they would be exempt from inheritance tax. The key risks are:

• The company's residence position may be closely scrutinised by the taxman, and it may be difficult to show that the central management and control is exercised outside the UK, particularly if all directors are UK resident and the asset of the company is a UK property. If HMRC is able to successfully argue that the company is UK resident, any gain on the disposal of the property would be subject to UK corporation tax and no PPR relief would be available.
• If the property is valued at more than £2Million the offshore company itself may be subject to UK CGT -- we look at this shortly.
• In addition, on a disposal of the shares in the company, no capital gains tax would be payable by Jack provided he remained non-resident. If he were UK resident, he may not be charged to UK CGT provided the proceeds were retained outside the UK and he were subject to the remittance basis, as he's a non-UK domiciliary.

12.4 TAX PLANNING FOR NON-RESIDENTS OWNING UK PROPERTY INVESTMENT COMPANIES

Many individuals hold their UK properties in a UK company.

When these individuals move overseas and lose UK residence, they will often hold onto their property company.

The company has to pay UK corporation tax on any rental profits. However, the shareholder can extract the remaining profits free of UK income tax/withholding tax and can always sell the shares in the company free of capital gains tax.

If the company sells the properties, however, corporation tax will have to be paid on the capital gains.

One important issue is financing the properties. This could come from either the UK or overseas.

UK financing is often preferred. The UK company would obtain a corporation tax deduction for the interest, but the shareholder could then extract the funds which could be invested overseas free of UK income tax. If the shareholder is resident in a tax haven, it may be possible to completely avoid income tax on the interest generated. This is potentially a win-win scenario with the interest being tax deductible in the UK company and reinvested overseas free of tax.

If financing is obtained from overseas the risk is that the tax deduction at source rules could apply. These can require tax to be deducted by the payer where the interest is from a UK source but the payment is made overseas. In the case of a UK company paying interest overseas, the net result is that the UK company may need to account for 20% income tax on the interest paid overseas.

The key issue is where the 'source' of the interest is. Revenue and Customs would look at a number of factors to determine whether the interest has a UK source:

• The residence of the debtor (this is usually taken to be the place where the debt will be enforced),
• The source from which interest is paid,
• Where the interest is paid, and
• The nature and location of any security for the debt.

If the loan were made to a UK company from overseas and in respect of UK property, it would be likely that the interest would have a UK source and as such be subject to the deduction of tax at source rules. Therefore whilst it would be deductible for the UK company when calculating its taxable profits, there could be a 20% income tax liability on the interest.

The options to avoid this are limited if the interest is paid overseas. A payment to a UK bank avoids these issues.

The main option to reduce withholding tax on interest paid overseas would be to rely on a double tax treaty. These provide for an exemption or reduction in UK tax deducted at source depending on the particular agreement that the UK has with the country in question. You could therefore ensure that the deduction at source from the UK was eliminated.

Transferring Properties to an Offshore Company

Another option would be to transfer the properties to an offshore company. The main tax issue here would have to pay corporation tax on any capital gain made up to the date of transfer.

So, this strategy works best if there has only been a nominal increase in the value of the properties.

A transfer overseas could, however, shelter you from paying tax on any future gains. If the properties remain in a UK company, any increase in value will be subject to UK corporation tax at a rate of up to 23% from April 2013.

If the properties are held by a non-resident, UK tax on the gain could be avoided. The rental income would fall within the non resident landlord scheme and an application would need to be made to receive the interest gross (without UK income tax deducted on the rental income).

Income tax (note not corporation tax) would be assessed via a self-assessment return. Any interest paid to a non resident lender could still be claimed as a tax deduction in calculating the UK taxable profits.

Another benefit of holding the properties via a non UK company would be if the shareholder has lost UK domicile. A non UK domiciliary would be subject to UK inheritance tax on the value of the UK shares if it were not a trading company.

By contrast a non domiciliary wouldn't be subject to inheritance tax on the value of overseas shares if the UK properties were held via an offshore company.

2013 Changes

In order to tackle the so called enveloping of high value properties into companies, the Government has adopted a threefold approach:

• with effect from 21 March 2012 a new 15% rate of stamp duty land tax (SDLT) applies on purchases of UK residential properties worth over £2 million by non-natural persons;
• from 1 April 2013 an annual charge will apply to UK residential properties valued at over £2 million owned by non-natural persons; and
• from 6 April 2013 the CGT regime will be extended to gains on the disposal of UK residential property, and shares or interests in such property, by non-natural persons who are non-UK resident or UK resident.

The aim is to discourage enveloping of property and all three proposals will run in tandem.

Any new purchases of properties worth more than £2 million by an offshore company will suffer a 15% SDLT charge on the purchase. The annual charge based on value will then be payable going forward and, disposals of the property will now be subject to CGT.

Non Natural Persons

The proposals don't just apply to "offshore companies". They include all "non-natural persons" which encompasses companies, collective investment schemes and partnerships in which a non-natural person is a partner.

However, the 15% charge will not apply to the purchase of a property by a trust even though one or more of the trustees is a company.

Annual charge

An annual charge will come into effect on 1 April 2013 and will be payable at the start of the period of account, i.e., by 15 April of each year. It is proposed that the charge will operate on a pro rata basis so that if the property is sold during the year, a repayment of part of the charge can be claimed.

A return will be required each year for each relevant dwelling within the charge owned by the non-natural person.

The return must include information on the property:

its address, Land Registry title, details of the 'beneficial owners' of the property and their address if different from the property address.

We do not yet know whether this will require simply details of, say, the company which owns the property or whether HMRC will need to be informed of the ultimate beneficial owners, for example, details of the shareholders or, if the company is held by a trust, details of that trust.

The levels of the annual charge will be set at:

• £15,000 pa for properties valued at between £2 - 5 million;
• £35,000 for properties valued at between £5 - 10 million;
• £70,000 for properties valued at between £10 - 20 million;
• £140,000 for properties worth more than £20 million.

Introducing an annual charge on capital values means that the UK now has its first form of wealth tax (a form of tax found in many European jurisdictions including France and Spain).

New CGT charge

The new charge to capital gains tax will not apply to trustees (although they may be subject to tax under other, existing provisions). However, contrary to the Treasury's previous announcements, the charge will apply to both UK resident and non-UK resident non-natural persons.

The charge will only apply to "ARPT-related gains": The ARPT-related gains are essentially the gains from 6 April 2013 or the day of acquisition (if later). If, for part of the period of ownership, the property was exempt from the Annual Charge, there is a reduction in the amount of gain subject to the capital gains tax charge to reflect this period of exemption.

In addition, where a UK resident non-natural person disposes of a property held pre-6 April 2013, the gains arising on a disposal will be split between pre-6 April 2013 gains and from 6 April 2013 gains. The gains treated as arising pre-6 April 2013 gains will be charged to corporation tax, if applicable, while gains from 6 April 2013 will be subject to capital gains tax. A seller may elect to be charged to capital gains tax instead for the whole gain and must make an election on their tax return if they wish to do so.

ARPT-related gains will not be attributed to shareholders in offshore close companies.

There are complex provisions regarding the use of any losses realised from the sale of high-value UK residential property. In essence, losses can only be used to offset future gains arising from the sale of high-value UK residential property. There are also provisions that deem a minimum consideration of £2 million on sale when calculating the loss available.

The rate of tax, and latent gains

It is envisaged that the CGT charge will only apply to disposals of residential property where the amount of the consideration for the disposal exceeds £2 million.

As stated above, there is to be 'grandfathering' (i.e., protection for) latent gains that have accrued but not been realised before the extension of the CGT regime.

Although the property market as a whole has seen prices fall or remain static in recent years, those at the higher end of the market have seen large increases and substantial gains could have been built up where properties have been held for a longer period of time.

The rate of CGT will be 28%.

Meaning of 'residential property'

The definition of residential property for these purposes will follow the meaning of 'dwelling' used for the 15% SDLT rate and the new annual charge.

The CGT regime will apply to disposals of residential property in enveloped structures irrespective of the use to which it is put. For example, it will apply to commercially let residential property.

What to do if you are caught by the new anti avoidance rules?

There are a couple of options that could be considered:

De-enveloping

One option is to remove the property from the ownership of the company and move it into personal ownership.

As a result of this new legislation, many people holding such property through BVI companies are thinking about "de-enveloping".

In most cases, the de-enveloping process will be carried out by

(i) placing the BVI (or other offshore) company into voluntary liquidation and then

(ii) distributing in specie the affected property holdings.

This avoids the new punitive tax regime, but it clearly exposes the ultimate beneficial owner (if a non-dom) to UK Inheritance Tax and results in the loss of confidentiality which they previously enjoyed. CGT may also be a determining factor in whether this is a viable option. There might also be other issues if the non-dom is resident in the UK.

Offshore trust structure

For many non-doms a preferable approach may be to convert their offshore company holding structure to an offshore trust holding structure. Corporate trustees are exempt from the above taxes and for most people transferring property already owned by an offshore company to an offshore trust may be the most cost effective way forward.

Where an offshore trust structure is already in place, with trustees holding a BVI company which in turn holds UK property, it might be advantageous to de-envelope the UK property (by liquidating the BVI company) so that the property is then held directly by the trustees.

Alternatively, if the BVI company is held directly by a non-dom, he or she may consider transferring the shares into an offshore trust now shortly before the BVI company is liquidated, with the same end result of the property then being held directly by trustees.

If the trustees are individuals, they should retire in favour of corporate trustees, so the tax exemptions can be enjoyed.

12.5 Conclusion

Deciding how a non-domiciliary should own UK property is clearly not a straightforward decision.

Much will depend on the particular circumstances and your personal preferences. For example, you may be more anxious to avoid capital gains tax than inheritance tax.

To a certain extent the simplest route -- direct ownership -- offers some important tax advantages provided potential inheritance tax can be avoided in some way, for example, by using debt.

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About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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