UK Resident Property Companies - Property Taxes

Introduction

The two years to 31 December 2010 have seen turmoil in the UK property market and have presented a number of challenges for property companies such as falling rentals, falling asset values, difficulties in raising finance and insolvent tenants. Despite this the UK property market remains a very important business sector. This briefing note outlines some of the key UK tax considerations for UK-resident property companies.

Investment Structures

Many UK companies make direct investments into UK property. However property investments are sometimes made via UK-resident subsidiary companies set up for a specific property purchase. This can offer UK stamp duty land tax (SDLT) savings on the basis that the acquisition and disposal of properties can be achieved via the sale of shares in a company rather than the property itself, thereby attracting a charge to stamp duty at a lower rate than SDLT that would be due on a direct property purchase.

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 can be neutral for capital gains tax purposes provided certain conditions are met. 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. Generally, however, where an interest in a property investment partnership changes hands for consideration in money or money's worth given outside the partnership by the person acquiring the interest, then there will be an SDLT charge for the acquirer and a CGT charge for the vendor.

Other types of investment vehicles may be appropriate depending on the type of investor (for example investment through an unauthorised unit trusts may be appropriate for pension fund investors), and consideration should always be given to the business and ownership aims when choosing an investment structure.

UK Corporate Tax position – property trading companies

UK resident companies pay corporation tax on their taxable trading profits at rates that depend on the level of profits and number of active associated companies in the worldwide group.

For profits that come within the period 1 April 2010 to 31 March 2011 the rates can vary from an overall rate of 21% up to 28%. The lower rate falls to 20% for profits arising on or after 1 April 2011 while the top rate reduces to 27%. A further 1% reduction in the top rate is planned year on year until the rate reaches 24% on 1 April 2014.

Expenses are deductible for corporation tax purposes if they are incurred wholly and exclusively for the purpose of the trade. Expenditure must be revenue in nature (although capital allowances may be available in respect of capital expenditure, see below) to generate a deduction from taxable profits. Tax relief may be available in respect of specific provisions made against the value of property held as trading stock.

This briefing note does not discuss loss relief in detail, and the use of losses qualifying as trade losses are different rules compared to those applying to capital losses.

Shareholders in property trading companies subject to UK income tax and capital gains tax are more likely to qualify for related UK tax reliefs and exemptions in respect of their shares than shareholders in property investment companies. These reliefs and exemptions fall outside of the scope of this note.

UK Corporate Tax position – property investment companies

UK resident companies undertaking property investment business pay corporation tax on their property business profits at rates that depend on the level of profits and number of active associated companies in the worldwide group, unless they are within the Real Estate Investment Trust (REIT) regime. Only certain companies and property businesses can enter the REIT regime, and exemption from Corporation Tax within the REIT is only available on the qualifying property business. Further discussion of the REIT regime is outside the scope of this briefing note.

Expenses are deductible for corporation tax purposes if they are incurred wholly and exclusively for the purpose of the property business. The expenditure must be revenue in nature (although capital allowances may be available in respect of capital expenditure, see below), and such expenses can be related to the property business or not, though different rules may apply to determine how such costs are offset. For example interest costs on loans to finance a property investment business will generate non-trade loan relationship deficits, which can be offset against current profits from other sources. However, where there is an excess deficit, this excess can only be carried forward to set against non-trade loan relationship profits or against capital profits. Provisions made against the value of investment property are not tax deductible when accrued, instead gains and losses on investment assets are taxed when realised.

Capital profits realised on the disposal of property are subject to corporation tax at the company's rate of corporation tax as determined. Gains are adjusted for an indexation allowance to reflect inflation since acquisition. Capital losses cannot be relieved against rental profits, but to the extent not set against capital profits in the year, can be carried forward indefinitely for offset against future capital gains.

Interest payable

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.

Depending on who the recipient is and other factors, it may be necessary to withhold UK income tax from interest payments at the basic rate (currently 20%).

Capital Allowances

Capital allowances may be available on capital expenditure (not 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 rate (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:

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
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.

Tax Compliance

UK-resident companies are subject to corporation tax by reference to their accounting date, with some modifications for periods exceeding one year. To the extent the company is "large" (broadly where it pays the highest rate of corporation tax) its tax liability is generally payable in quarterly instalments which fall due during and following the period.

The due date for tax payments for companies which are not large is nine months and a day following the accounting date, again with modifications for periods exceeding one year.

Corporation tax returns covering a 12 month period need to be filed within a year following the accounting date. For corporation tax returns due on or after 1 April 2011 (for accounting periods ending on or after 1 April 2010) the tax return and supporting information (such as company accounts and tax computation) must be filed electronically in iXBRL format.

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 on related costs are recoverable on acquisition but must then be charged on rentals and on the eventual disposal of the property. Whether to opt to tax an investment property often depends on the profile of the target tenant and whether they can recover input VAT. 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.

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% for commercial property, depending on the level of chargeable 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

There are a number of potentially complex and varied tax issues affecting property companies. Companies are taxed differently depending on whether they are trading in property or holding it as an investment. The availability of a tax deduction of interest payable is often an important issue for property companies.

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.

UK: UK Resident Property Companies