High Value Residential Property In The UK

1. INTRODUCTION

The UK Government has announced a number of changes that impact on the purchase and ownership of UK residential properties. Some of these measures were detailed in the Budget on 21 March 2012 and are already in force. Details of further measures have been included in a consultative document issued on 31 May 2012 and these are due to take effect from April 2013.

2. A SUMMARY OF THE CHANGES

• The highest rate of SDLT is increased to 7% for purchases of UK residential property over £2 million by natural persons (from 22 March.2012).
• New 15% SDLT rate on purchases of UK residential property over £2 million by "non-natural persons" (from 22 March.2012).
• Mansion Tax" – Annual SDLT charge on UK residential property worth over £2 million held by "non-natural persons" (for periods from 1 April 2013).
• CGT charge on disposals of UK residential property over £2 million by non-resident "non-natural persons" (including trusts?) (from 6 April 2013).

3. WHY HAVE THESE MEASURES BEEN INTRODUCED AND WHO ARE THEY LIKELY TO AFFECT?

In his Budget speech George Osborne said;

"A major source of abuse – and one that rouses the anger of many of our citizens – is the way some people avoid the stamp duty that the rest of the population pays, including by using companies to buy expensive residential property. ............Let me make this absolutely clear to people. If you buy a property in Britain that is used for residential purposes, then we will expect stamp duty to be paid. That is the clear intention of Parliament."

So it would seem that the intention of parliament was to clamp down on a perceived avoidance of SDLT. But it is unclear as to the extent of the amount of SDLT that is avoided in this manner. SDLT has always been payable by a company on its initial purchase of the UK property. There would be an SDLT saving by a subsequent purchaser of the property only where a subsequent purchaser bought the shares in the company rather than the property itself.

The initial purchaser might however hope that the subsequent owner would be prepared to share the SDLT savings. Furthermore, there is always a risk that the company which owns the property has incurred liabilities of which the buyer is unaware and the costs of due diligence and warranties and guarantees may outweigh any SDLT saving.

However the main reason why UK properties are acquired through corporate structures is not to avoid SDLT but to ensure that the UK property is not liable to UK Inheritance Tax where the individual is not UK domiciled and the property is owned through a non resident company.

UK properties are also held in non resident companies by Non-Resident landlords so as to reduce the income tax charge on the letting income and also to protect the properties from UK Inheritance Tax.

A company can also be used simply to protect the anonymity of the purchaser.

Other reasons include avoiding the need for a UK probate or reasons connected with another jurisdiction with which the individual is connected.

4. CHANGES IN DETAIL

4.1. 7% rate of SDLT on consideration of more than £2 million

This is simply an extension to the normal existing rates of SDLT on UK residential property.

A 7% rate of SDLT will apply to residential property transactions valued at more than £2 million with an effective date (normally completion) on or after 22 March 2012, though there are transitional measures in respect of contracts made before 22 March 2012 but completed on or after that time (where the 5% rate would apply). Essentially contracts entered into before 22 March 2012 can continue to apply the old rates, unless:

• there is a variation of the contract; or
• an exercise of any option, right of pre-emption or similar right on or after 22 March 2012; or
• there is an assignment, subsale or other transaction relating to the subject matter of the transaction so that a person other than the purchaser under the contract becomes entitled to call for conveyance.

The standard rates of SDLT payable on land purchases are now as follows:

Rate	Residential	Non-Residential
0%	Up to £125,000	Up to £150,000
1%	£125,001 to £250,000	£150,001 to £250,000
3%	£250,001 to £500,000	£250,001 to £500,000
4%	£500,001 to £1,000,000	£500,001 to £1,000,000
5%	£1,000,001 to £2,000,000	Over £1,000,000
7%	Over £2,000,000

This measure will affect all purchasers of high value property, except for certain company, partnership or collective investment scheme purchasers who are within the 15% charge detailed below.

4.2. 15% rate of SDLT on consideration of more than £2 million where UK residential property acquired by "non-natural persons"

Where the acquisition of a UK residential property in excess of £2 million is by a "non-natural person" the rate of SDLT payable on the purchase will be 15% rather than the 7% rate outlined above. This effects all purchases entered into on or after 22 March 2012 and the same transitional measures apply as for the 7% rate.

"Non-natural persons" for this purpose means companies, collective investment schemes (including unit trusts) and partnerships where at least one of the partners is a company. It is irrelevant whether these are UK or non-UK entities.

There are certain companies and partnerships excluded from the 15% charge as follows:

• A company does not include a company acting in its capacity as a trustee of the settlement;
• a bona fide property development business is excluded provided that:
• • the property is acquired in the course of a bona fide property development business; and
  • the business has been operating for a minimum of two years; and
  • the property was purchased with the intention of re-development and r-sale (note that development and letting is not excluded).
• Charities are excluded from the charge.

4.3. Annual SDLT charge on UK residential property worth over £2 million held by "non-natural persons"

The consultative document proposes that the annual charge will apply to the same categories of non-natural person as the 15% rate of SDLT, namely:

• Companies;
• Collective investment schemes; and
• Partnerships that include a company.

The same exclusions for property developers, trustees and charities also apply.

The first annual charge will arise on UK residential properties owned at 1 April 2013 and will be payable in advance for the period 1 April 2013 to 31 March 2014.

The amount of the annual charge depends on the market value of the property. If the property was owned on 1 April 2012 the value at that date will used to calculate the charge at 1 April 2013, for properties acquired after 1 April 2012 the value at the date of acquisition will be used. Properties will have to be revalued every 5 years so for properties held at 1 April 2012 the next valuation date will be 1 April 2017 which will form the basis of the April 2018 annual charge.

The annual charge will be self assessed so those persons liable to the charge will be responsible for obtaining the market value of their property at the respective dates. The due date for returns and payment of tax will be normally be 15 days after the charge date, i.e. by 15 April of each year. But for the first year the due date will be 1 October 2013 or, if later, 30 days after Royal Assent is given.

The proposed bands and annual charge for 2013/14 are as follows:

Property Value	Annual Charge April 2013
£2m - £5m	£15,000
£5m - £10m	£35,000
£10m - £20m	£70,000
£20m	£140,000

The annual charge will be indexed to the Consumer Price Index (CPI) and uprated each year. But there are no proposals to uplift the rate bands with the CPI.

If the property is not held for the whole of the charge period the charge will apply pro-rata. Likewise for properties which move into or out of the Annual Charge (e.g. due to conversion from commercial property to residential property, or vice versa).

4.4. CGT charge on disposals of UK residential property over £2 million by non-resident "non-natural persons"

Under existing legislation it is widely known that Capital Gains Tax (CGT) is only payable by UK residents. Anti avoidance legislation treats gains on disposals by non-resident companies and trusts as accruing to UK resident individuals in certain circumstances.

However the consultation document proposes that CGT will now be levied on disposals of UK residential property by non-resident "non-natural persons" from 6 April 2013 where the value of the consideration for the disposal exceeds £2 million.

The category of non natural person for CGT is likely to have a wider definition than that for the 15% rate and the annual charge. It will include companies but may also include:

• Trusts;
• personal representatives and executors;
• clubs and associations (but not charities); and
• entities that exist in other jurisdictions that allow property to be held indirectly (which will include certain foundations, stiftungs and anstalts etc)

The inclusion of these categories is however the subject of consultation and the professional bodies are making representations that these categories are not appropriate because unlike companies they have not been used for SDLT avoidance which is the purported target of the new measures.

The CGT charge will apply to gains on the disposal, or part disposal, of relevant UK residential property, including the grant of an option over such property.

It is proposed that the definition of residential property follows the meaning of "dwelling" used for the 15% SDLT rate and the new annual charge, as follows:

"A building or part of a building counts as a dwelling if –

1. it is used or suitable for use as a single dwelling, or
2. it is in the process of being constructed or adapted for such use.

Land that is, or is to be, occupied or enjoyed with a dwelling as a garden or grounds (including any building or structure on such land) is taken to be part of that dwelling.

Land that subsists, or is to subsist, for the benefit of a dwelling is taken to be part of that dwelling."

It is understood that HMRC take the view that a dwelling's gardens or grounds has the same meaning as would apply to land associated with a dwelling for principal private residence exemption for CGT. This has implications for country estates owned by non-resident non natural persons.

4.5. CGT charge on disposals of UK residential property over £2 million by non-resident "non-natural persons" (continued)

It is proposed that this charge will also apply to the whole of any gains that accrue on the disposal of assets (of whatever form) that represent directly or indirectly relevant UK residential property. This will include shares, interests or securities in a property owning company where more than 50 percent of the value of the asset is derived from UK residential property (it is not clear whether this 50 percent must represent just properties worth over £2 million or whether it refers to all UK residential properties held by the company).

The gain will be calculated following normal CGT rules (there is no comment in the consultation document as to whether indexation allowance will be available for companies within the charge). The charge will apply to the total gain arising over the whole period of ownership of the property (and not only the gain accruing from the implementation of the new charge in April 2013).

If losses arise on the sale of properties within the charge, these will only be available to set against gains on disposals of UK residential property in the same or future years.

Gains (and losses) will be reduced where the property was not a residential property throughout the period of ownership.

The rates of tax payable have not been announced.

Non-UK resident companies currently liable to corporation tax (because trading in UK through a permanent establishment) will pay corporation tax on the gain, presumably at corporation tax rates of up to 23% for 2013/14.

Other non-UK resident non-natural persons will pay capital gains tax, presumably at 28%.

There will a review of the interaction of the new CGT charge with existing charges such as TCGA s13, s86 and s87 with the aim of avoiding unnecessary complexity and to ensure a sensible prioritization of charging provisions.

Private residence relief will only be available where it would have been available to a resident non-natural person under the existing CGT regime. Basically this means that private residence relief may be available under the new regime where the property is owned directly by a non-resident trust and occupied by a beneficiary of the trust as a main residence.

5. PLANNING FOR BUYING NEW PROPERTIES

The main tax advantage to a non-UK domiciled individual of holding a property through an offshore company is that the value of the property is sheltered from inheritance tax, but the impact of the 15% SDLT on purchase, the annual charge and new capital gains tax charge may outweigh this benefit.

Non domiciled individuals looking to purchase residential property in the UK may well be best advised to acquire the property personally and look at alternative means of dealing with the IHT position. If the individual is not UK resident, or if the property qualifies as a main residence, this method would also avoid any CGT on a sale of the property.

Ways of reducing the potential IHT liability for a non-UK domiciled and non deemed domiciled individual include:

• Life assurance – the availability and cost of this will depend on the individual's age, health and country of residence.
• Using debt secured on the property to reduce its value for IHT purposes. The debt does not necessarily have to be with a commercial lender, indeed there are ways in which the debt can be self generated using an offshore trust and offshore company structure as follows: –
• • Individual settles cash into a new offshore trust.
  • Trust capitalises or lends to a new offshore company.
  • Offshore company lends to individual.
  • Individual acquires the property and secures the debt to the company against it.

If trusts are not brought within the new CGT rules, direct ownership by trustees may be effective when combined with debt, to mitigate potential CGT and IHT liabilities.

6. EXISTING STRUCTURES - WHAT SHOULD WE BE DOING NOW?

Draft legislation on the annual charge and the CGT charge are before the end of 2012 and it would be wise to wait until this has been published before undertaking any restructuring of existing property structures (particularly in view of the possible changes to the classes of non-natural persons relating to the CGT charge). However as there will not be much time before the legislation takes effect it will be necessary to move fairly quickly once confirmation of the changes are known.

There will be no generic right answer for each type of structure, each one will need to be considered taking account of the individual facts of each situation. During the period between now and the date of publication of the draft legislation we would suggest that this time is used to obtain all the necessary facts so an informed decision can be made.

The information that will be needed includes:

• Obtaining valuations (as at 1 April 2012) of potentially liable property.
• Where is the property and how is it used (is it a family home or a London pied-à-terre)? Would the property qualify as a main residence for CGT?
• Who actually owns the property and under what terms is it occupied?
• What finance is secured on the property and on what terms?
• What is the capital gain to date on the property?
• Are there any imminent plans to sell the property?
• Why was the property put into a company or trust in the first place?
• Are these reasons still valid?
• What is the age, state of health and marital status of the individual?
• What is the residence and domicile status of the individual and his family?
• How long does the family expect to stay in the UK?
• What is the status of the existing trust structure, is it an excluded property trust?
• Are there any unmatched capital payments or unmatched gains in the trust?

7. PLANNING FOR EXISTING STRUCTURES

As previously explained there is no one size fits all answer and each situation will need to be looked at in detail to arrive at the correct course of action. The precise way forward will depend on whether or not offshore trusts are actually caught within capital gains tax definition of a non-natural person when the draft legislation is published.

Some individuals may decide to keep existing structures and pay the new taxes so as to either keep the current inheritance tax protection or to protect the property from tax charges in other jurisdictions.

A lot of people will however want to restructure how their UK residential properties are held in order to avoid the new tax charges. The problems will be avoiding any SDLT or CGT on any transfers and ensuring that the property does not create a potential IHT liability. The position will depend to a large degree on the residence and domicile status of the individual concerned.

7.1. Non-Residents

Non-UK residents should consider winding up companies owning high value UK residential properties and instead holding the properties personally or (depending on the outcome of the consultation) via a trust. This will be fairly simple to achieve without incurring any UK tax liabilities, provided action is taken before next April. Inheritance tax can be mitigated by using life assurance or borrowings. A non-UK partnership may also have IHT benefits.

7.2. UK Resident & Domiciled

For individuals who are both resident and domiciled in the UK, it is likely that any restructuring will give rise to capital gains tax liabilities on any unrealised gains in the structure. So a decision will need to be made as to whether to pay the CGT on a restructuring or to accept the annual charges and CGT on the eventual sale. The decision will depend on the facts of each case.

7.3. UK Resident but Not UK Domiciled

This is probably the most complicated position, but probably also the most likely scenario. Without careful planning any restructuring is likely to give rise to a capital gains tax charge on unrealised gains in the property.

However there may be ways in which this can be done without incurring any substantial tax charges, depending on the circumstances of each case. For example where trust rebasing election at April 2008 has been made or can be made.

Let us consider the common holding structure whereby a property is owned by a non resident company, which is in turn owned by an offshore trust. The property is occupied by a beneficiary of the offshore trust.

The two questions that need to be considered are:

• How to break the property out of the structure and the tax implications thereof.
• How to create the debt to secure against the property to reduce the IHT liability.

The easiest way to extract the property would be for the company to sell it to the individual. This would naturally create the required debt simply by leaving the consideration outstanding but could lead to benefit in kind issues on directors and shadow directors. However, this sale would give rise to an SDLT charge of 7%, which is likely to be too expensive in most cases, although there may be circumstances where this may be worthwhile depending on the potential costs of keeping the property in the company.

The company could sell the property to the individual at an undervalue e.g. £1. This would not give rise to an SDLT charge as the legislation only imputes market value where the transferee is a company connected with the transferor (s53 FA 2003). However, again there is a high risk that the individual would be seen as a shadow director of the company as he would be directing the undervalue transfer. This would give rise to a benefit in kind charge on the market value of the property if he is UK resident. Therefore these two options are only likely to be an option if he is non-resident (and subject to the rules in the territory of residence).

Depending on the circumstances and history of the overseas structure it may be possible to use the following method to get the property into the individual's personal ownership:

This assumes the following fact pattern:

• The individual is resident and non-UK domiciled/non deemed domiciled.
• He pays the remittance basis charge, where relevant.
• The trust is a discretionary trust of which the individual is both settlor and amongst the beneficiaries.
• The property is standing at a gain.

1. The UK property is first distributed up to the trust by way of a liquidation of the company.
2. The trustees make a distribution payment to the individual offshore of an amount equal to the capital gains arising on the distribution in the same tax year as the gains arise.
3. The UK property can then be distributed to the individual in the following tax year. However, it may be possible to leave the property in the trust (see below).

It is unlikely that the trust will have sufficient funds to make the distribution in stage 2, therefore, the individual will probably have to settle further funds on the trust.

The capital payment distributed could be settled by the individual into a new offshore trust and then invested by the trust into a new offshore company, in order to be loaned back to the individual to create the secured debt required to provide the IHT shelter.

Alternatively, IHT shelter could be achieved by the simple route of taking out life cover.

There are however many dangers in connection with this course of action which must not be overlooked and need to carefully considered so as not to trigger a tax charge. These include:

• Any undistributed income in the trust.
• Prior capital gains.
• Periods of rent free occupation.
• Trust loans.

Alternatively, consideration could be given to simply leaving the property in the trust. This would eliminate the annual SDLT charge since a trust is not a non-natural person for this purpose (assuming the same rules are adopted as for the 15% charge). The disadvantage is that it is likely that an offshore trust will be within the new CGT charge. However (based on the consultative document), if the individual would be entitled to private residence relief the trustees should also be able to benefit from this provided the individual is occupying the property as a beneficiary of the trust.

The extent to which this matters or not will depend on the longer term intention of the individual with regard to the property and to his future residency status. It would also result in 10 yearly IHT charges on the trust. Again this may or may not matter depending on circumstances. It is also noteworthy that the 10 year charge regime is under review and may be scrapped.

Alternative structures which are also being considered include using non resident partnerships, such as a Guernsey Limited Partnership and other look through corporate entities.

However any aggressive planning should be viewed with a note of caution as in his budget statement in March the Chancellor said that in relation to the new stamp duty legislation

"I will not hesitate to move swiftly, without notice and retrospectively if inappropriate ways around these new rules are found.

People have been warned."

8. CONCLUSIONS

Using internally generated debt secured against the property would seem to work well on new property acquisitions, and would enable the property to be acquired by the individual personally, so avoiding the penal SDLT enveloping charge.

Unwinding existing structures to get a property into the ownership of the individual may be more difficult. If the individual is non-resident this may be more straightforward depending on the tax rules in his country of residence. If he is UK resident then whether the solution is viable will depend on the particular facts and circumstances. However, as outlined it should be possible to do this by washing out the gains.

Anonymity could be preserved via appropriate nominee/bare trust arrangements. This should not prejudice any of the tax analysis.

Before rushing into any restructuring it is advisable to wait until we see the results of the consultation on the new proposals which should be announced in late 2012.

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.