UK: Corporate Non-UK Resident Property Investors

Introduction

Despite turmoil in the UK property market over the two years to 31 December 2011, a combination of the weak pound and a favourable tax regime has meant that UK property has remained attractive to non-resident investors. This briefing note outlines some of the key UK tax considerations for non-resident companies who hold UK property as an investment asset. The UK tax position of a non-resident company which trades in UK property is very different to that outlined below and is not discussed in this note.

Investment Structures

Many offshore companies make direct investments into UK property. However investments are sometimes made via non-resident subsidiary companies set up for a specific property purchase. This can offer UK stamp duty land tax savings on the basis that the acquisition and disposal of properties can be achieved via the sale of shares in a non-resident company potentially avoiding both UK stamp duty and stamp duty land tax charges.

Property funds often invest in property via a partnership structure. A limited partnership structure is usually chosen due to its flexibility. Partnerships are generally tax transparent for UK tax purposes and each partner is treated as owning a direct interest in the underlying property. Changes in profit sharing ratios are generally neutral for direct tax purposes, assuming the place of residence remains outside the UK. Such partnership changes can be made without SDLT charges but the transaction, and the history of the partnership's acquisition of the property interest included in the transaction, must meet certain conditions.

Other types of investment structure may be appropriate depending on the type of investment business and investor profile.

UK Income Tax position

Tenants or letting agents (as appropriate) are generally obliged to withhold UK income tax at the basic rate (currently 20%) from rental payments to non-resident landlords and report and pay it over to HM Revenue & Customs ("HMRC"). Non-resident companies may then self-assess their income tax liability in respect of their rental profits by submitting a tax return to HMRC in the normal manner. This permits them to claim deductible expenses against their income which will generally reduce their actual tax liability and may result in a repayment of tax.

It is normally preferable for non-resident landlords to register under HMRC's Non Resident Landlord Scheme ("NRLS") to receive rental income gross. Assuming their application is approved HMRC will send a notice of approval to receive rent gross to the landlord and a separate notice to the letting agents or tenant authorising them to pay rent gross. The landlord is then required to file annual income tax returns to self-assess their actual UK tax liability. Registration under the NRLS offers a cash flow advantage as the tax liability under self-assessment is generally far lower once rental expenses are taken into account.

Regardless of whether the landlord registers under NRLS the company will be subject to the basic rate of income tax (currently 20%) on rental profits.

Tax deductible expenses

In calculating rental business profits a taxpayer can deduct expenses so long as they are incurred wholly and exclusively for rental business purposes and are not of a capital nature. Depreciation is not a tax deductible expense but relief may be available for capital allowances (see below).

The tax deductibility of interest payable is a very complex area, particularly where there are connected party borrowings and where interest is payable overseas. The tax deductibility of interest is usually a key commercial concern and is often an area where specialist advice is required.

To the extent that interest payable by the landlord in respect of a property acquisition that has a UK source it will generally be subject to UK withholding tax at the basic rate (currently 20%) when paid to another non resident or to individuals and certain other categories of lender. Source is determined by the following factors:

  • Residence of the debtor;
  • Residence of the creditor;
  • What the loan is used for;
  • The contract under which the interest is paid, the place it is made and the place in which the debt will be enforced;
  • Source from which the interest is paid;
  • Where the interest is paid; and
  • Nature and location of any security or guarantor for the debt.

No one factor is conclusive – it is necessary to consider the factors "in the round". It is generally thought that interest should not be regarded as having a UK source only because it is secured on a UK property.

Capital Allowances

Capital allowances may be available on capital expenditure (not on property held as trading stock) to the extent that it relates to qualifying plant and machinery. Capital allowances allow relief for capital expenditure over a period of time at a prescribed rate depending on the nature of the expenditure. The rates of allowance depend on the type of expenditure and can range from 100% to 10% of qualifying acquisition expenditure (the lower limit will become 8% on 1 April 2012). 100% allowances are available for certain energy and water efficient plant or machinery (and there is also a 100% annual investment allowance for a limited amount of any qualifying expenditure, currently £100,000 annually, but falling to a maximum of £25,000 for expenditure incurred on or after 1 April 2012).

Other types of qualifying expenditure may qualify for a 20% or a 10% rate of writing down allowance, though these rates drop to 18% and 8% respectively for expenditure incurred on or after 1 April 2012. Special rules apply on the acquisition of a second-hand building, but no opportunity to claim allowances should be overlooked.

In a rental property fixed (integral) assets such as electrical systems, cold water systems, heating and ventilation systems, lifts and external solar shading should qualify for the 10% allowance (8% from 1 April 2012). Other (non integral) fixtures such as furniture may qualify for 20% (18% from 1 April 2012) writing down allowances for the same period and elections may be possible to shorten the time period in which such assets are fully written down.

There are however special rules in relation to furnished residential property. Capital allowances cannot generally be claimed on furniture, furnishings or fixtures within furnished residential property qualifying as a dwelling. Instead a deduction can be claimed under an extra statutory concession for either:

  1. a wear and tear allowance of 10% of the 'net rent' from the furnished letting to cover the depreciation of plant and machinery, such as furniture, fridges etc supplied with the accommodation, or
  2. the net cost of replacing a particular item of furniture etc, but not the cost of the original purchase; this is called a 'renewals allowance'.

There has been a move to legislate extra statutory concessions, though this one has not yet been listed. As far as we know there is no intention to change the rate of allowance for wear and tear.

As a matter of law fixtures in a building will become part of the building, so on disposal of the building (if still in situ) will be sold to the purchaser. Where the disposal proceeds mean there is a capital gain, despite the fact that the fixtures may have qualified for capital allowances deductible against profits, the full acquisition cost should also qualify as part of the base cost of the property for capital gains tax purposes. Depending on whether elections or other transfer provisions apply, and the disposal value attributable to plant or machinery, there may be a balancing charge or allowance to bring into account for capital allowance purposes. In relation to plant or machinery which are fixtures it may be possible to avoid any balancing charge altogether by signing a joint election to agree a tax disposal value of £1, and this is usually a negotiation factor on any disposal.

One further point that can be relevant to whether capital allowances are available is whether the property business is viewed as an investment or trading business. If regarded as trading, no capital allowances or indexation allowances will be available for expenditure on trading stock, and if an investment property is sold shortly after acquisition. HMRC may consider whether a transaction should properly have been considered a trading transaction instead of an investment transaction. Potential reclassification as a trading transaction would create other tax problems as any profit is likely to be chargeable to UK tax.

UK tax on capital gains

Non-residents are generally outside the scope of UK tax on capital gains realised on UK investment property. There are some exceptions where gains will be taxable in the UK as follows:

  • Where property in the UK is held as a trading asset rather than as an investment. HMRC could challenge whether assets held as investments are actually held for trading purposes (if so, any capital allowances claimed against other property profits may be disallowed, and the profit will be chargeable to UK tax).
  • Where property in the UK is an investment asset but it is used for the purposes of a trade carried out in a UK permanent establishment by the landlord (for example where the property concerned is a hotel and the trade is operated by the landlord either directly or via agents).
  • There is also a specific anti-avoidance provision targeting situations where land is acquired with the sole or main object of realising a gain from developing or disposing of the land (i.e. as opposed to enjoying rental income), in which case there may be a risk of being regarded as trading in the UK.

Clearly the income versus capital distinction is a very important and high risk area for non-resident landlords who should take advice on a case by case basis.

Tax Compliance

Non-resident landlords are subject to income tax by reference to a 5 April year end in a similar manner to individuals subject to UK tax. Their tax liability is generally payable in two instalments due on 31 January during the tax year and 31 July following the tax year end based on the prior year's tax liability. Any balancing payment is due on 31 January following the tax year end.

VAT

Consideration needs to be given as to whether to opt to tax a property purchase. The consequence of opting to tax is that VAT incurred on related costs are recoverable but VAT must then be charged on rentals and on the eventual disposal of the property. Whether to opt to tax a property often depends on the profile of the tenant and whether they can recover input VAT. VAT is not chargeable on certain types of property such as residential property. Certain types of property such as second hand residential property, are however exempt from VAT, while other types of property (such as the first grant of a newly constructed residential property) are zero rated.

Input VAT recovery on business expenses will depend on the VAT status of sales the business makes. If all the sales are subject to VAT (whether subject to standard, reduced or zero rate) then there should be full input VAT recovery on expenses unless a specific rule of non-recovery applies. Businesses that have VAT exempt sales will be subject to some sort of restriction on input VAT recovery, depending on the extent of the VAT exempt sales.

If all activity is to consist of VAT exempt activity, then there is no requirement to register for VAT in the UK, but there will be no opportunity to recover VAT incurred on costs.

The place of supply rules for property companies (governing the place where VAT is levied) can be complex, particularly where the transaction involves cross border activity.

Stamp Duty Land Tax (SDLT)

SDLT is chargeable on transactions in UK property at rates of up to 4% commercial property depending on the level of consideration and whether the property transaction involves a lease. Different exemptions and bands apply for residential and commercial property, and the top rate for residential properties where chargeable consideration exceeds £1m is 5% (4% for transactions prior to 6 April 2011).

Conclusion

The taxation of corporate non-resident landlords can be highly complex and the distinction between trading and investment receipts is paramount to the UK tax position. The availability of a tax deduction of interest payable is often an important issue for landlords.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Richard Mannion
Mark Webb
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