UK: Non-Resident Capital Gains Tax on United Kingdom Real Estate: A New Regime

Last Updated: 24 July 2019
Article by STA Law Firm

Introduction

The legislation encompassing the new regime for taxing non-residents' gains on the United Kingdom (UK) commercial real estate came into effect on 6th April 2019. Her Majesty's Revenue and Customs (HMRC) has additionally published draft guidance on this recently introduced regime. This article briefly summarizes the new rules.

What is Capital Gains Tax?

Capital Gains Tax (CGT) is such tax which is due as a result of financial gain, which is often referred to as profit which is received once an asset is disposed or sold off. When the sale value is subtracted from the original purchase value, the remainder is the total gain.

For more clarity, if you are selling an asset, the sale value will generally be the sale price of that asset, or in certain cases, the current market value which the asset could be reasonably projected to sell for in an open market. The market value is used in instances where a property is given away, sold at subsidized cost or when the property is passed to a connected person, like a family member. Additionally, market value is used while calculating the original cost of the property in instances where such property was inherited or was owned prior to 31st March 1982. Costs of improvements made to such property during ownership, excluding maintenance and decorations, may be deducted.

Upon the calculation of total gain, one may apply for any allowances and/or tax relief before calculating the CGT using appropriate rate.

Background

Historically, United Kingdom Capital Gains Tax had a territorial limit, and with a few recent exceptions (relevant to residential property) non-United Kingdom residents have remained outside the scope of UK CGT on their investments. Consequently, the UK made an attractive jurisdiction for inward investment, giving foreign investors an incentive to choose the UK over other jurisdictions that have long taxed foreigners on their gains. A great degree of flexibility was brought due to CGT's territorial limit in creating tax neutral fund structures and co-investment. The absence of Capital Gains Tax allowed investors with such exemptions which include charities, sovereign wealth funds and pension funds to co-invest in the real estate market along with those without such exemptions without tax leakage, and it is this flexibility which was vital to facilitating joint ventures between those with cash-rich institutions and management expertise.

Basic Rules

The non-UK residents are subject to tax on all gains realized on their assets in the UK real estate with effect from 6th April 2019. The new regime taxes both indirect and direct disposal of commercial as well as residential real estate by non-UK residents. The sale of interests in "property rich" vehicles are indirect disposals.

A vehicle is considered property rich when it derives a minimum of 75 per cent of its value from real estate in the UK. Those investors who holder less than 25 per cent of the vehicle, in limited circumstances, will be considered outside the purview of the charge. Interests held with related parties are aggregated, and the above threshold of 25 per cent does not apply in cases where the vehicle is a type fund including real estate investment trusts. However, the 25 per cent threshold would apply to such investors who are marketed on the bases that not exceeding 40 per cent of their total investments are projected to be in real estate in the UK. This safeguards that investors with small stakes who were not marketed as real estate funds in the UK, but are property rich at the time when the investor disposes of such interests, will not be subject to CGT on their gain.

For commercial properties, an option of rebasing was available till the 5th of April 2019, which meant that investors would only be subject to CGT on the gains that arise from the 6th of April 2019 onwards.

Trading Exemption, Qualifying Institutional Investors and Substantial Shareholdings Exemption

There is a trading exemption in the new rules which apply to the sale of companies with heavy trades in real estate. The above exemption is specifically valuable to private equity funds investing in restaurants, retail and hotel chains. The disposal of such company that some of its land used for non-trading purposes may benefit from this exemption on a condition that such company's non-trading land accounts for less than 10 per cent of the value of its total property.

The already existing SSE, short of 'substantial shareholdings exemption', which is available for trading companies, continues to be available for them. It can be more plentiful on the basis that activities that non-trading in nature uses 20 per cent threshold to determine if the trading requirement is met or not.

Where a property rich company is owned by qualifying institutional investors (sovereign wealth funds, charities and pension funds) with an appropriate proportion of 80 per cent, for SSE purposes, the trading requirement is dropped.

The essential benefit of this trading exemption is its availability to non-corporate shareholders like unit trusts and individuals, which is unlike substantial shareholdings exemption. Where the trading exemption or the SSE is claimed on property rich company's sale, the target does not benefit from the similar rebasing of its real estate assets as entities sold by funds under the new regime.

Double Tax Treaties

A non-resident investor can only be taxed by the UK if the terms of a double tax treaty between the United Kingdom and jurisdiction of a non-residents permits it. Amongst the double tax treaties that the UK is a party to, most of them allow the UK to tax non-residents on disposals of vehicles that are UK property rich as well as the direct disposal of real estate in the UK.

The Luxembourg/UK treat is an exemption to the above. This treaty prevents the UK from taxing on gains which are disposals by Luxembourg residents of interests in property-rich vehicles in the UK.  Several joint ventures and real estate funds use Luxembourg vehicles, and this protection under the treaty will effectually preserve the current capital gains tax treatment of such vehicles.

The process of renegotiation by the UK concerning this provision in the Luxembourg Treaty is on, so it is fair to presume that such protection may not last long. But it is also important to note that renegotiating double tax treaties can take a lot of years. The new regime includes rules that prevent the establishment of new structures in Luxembourg to take advantage of the UK/Luxembourg Treaty protection from capital gains tax.

Application of Funds

When the new regime was announced, one of the main concern that arose was regarding the treatment of funds including other collective investment vehicles which commonly use non-UK holding vehicles for their investments in real estate. The pension funds in the UK and the other institutional investors hold a huge proportion of the real estate investments vide these structures, and additionally, without special rules these vehicles would be subject to tax, resulting in the investors suffering tax at the fund level, where they would not if they held these assets directly. They would have also faced from their sale prices being discounted by the buyers for "latent" gains in the structure. Also, funds with master holding vehicle could have been liable to multiple charges on a single gain.

This issue has been largely addressed in the engagement between the industry and HMRC. Joint venture vehicles and funds can enter into elections, which will have the effect of shifting gains in the holding structure up to the investor's level. This would allow pension funds along with other exempt entities to benefit from such status of exemption, and receive their profit free of tax.

It is important for these elections to ensure that tax leakage is prevented at the fund level and that exempt investors continue to be attracted to investing in real estate in the UK via joint ventures and funds without facing additional tax that they would as against their direct investments. The downside of such funds electing is that they will subject to more reporting obligations. The introduction of new rules is being considered by the government that would allow for returns to be filed for funds as well as pay taxes on behalf of their investors, which would indubitably alleviate this. However, any of these rules look unlikely to be introduced for a while. Blocked vehicles could be used in the meanwhile to shift the burden of compliance from investors to the fund, in cases where investors are not willing to file UK returns.

The Transparency Election

A collective investment vehicle that is transparent for income tax can elect to be so for CGT purposes as well. Where such an election is made, it will be considered as if the investor held the property directly or technically in partnership with another investor(s). When the property is sold, it is treated underlying property being sold by the investor.

For clarity, it means that investors that are exempt, would not be taxed on disposals by the vehicle. Additionally, the taxable investor is subject to tax only once. Since the vehicle is transparent in nature, there is no latent gain in the vehicle due to which the buyer may discount the price. In light of the above advantages, it is likely that the investors will opt for transparency.

It is pertinent to note that this election is irrevocable and it must be made within a year of such vehicle acquiring United Kingdom property. For transparency elections, the consent of all unitholders is required.

The Exemption Election

Joint ventures and real estate funds with non-UK vehicles that meet certain conditions may elect to be exempt from capital gains tax. The rules are complicated. In broad terms, a fund must either be non-close and have less than 25 per cent protected investors, or it must meet an extensively marketed test. Structures that are controlled by five or less than five participants are closed, though certain qualifying investors such as real estate investments trust, sovereign wealth funds, pension funds to name a new, are disregarded for these purposes. Several joint ventures where such investors are involved should be able to profit from this exemption election even though they have not been marketed.

The fund vehicle in his entirety is tax exempt when this election is made. Additionally, all of its subsidiary vehicles will be exempt from tax as well.  Gains realized by joint ventures that hold a minimum of 40 per cent in the exempt fund will also profit from the proportionate exemption. Essentially, these exemptions apply to both non-Uk and UK subsidiaries. Real estate assets of the property holding vehicle are rebased when such vehicle leaves an exempt fund. This ensures that a buyer does not assume latent gains which result in price discounting.

These funds must provide up to date and correct information related to the fund disposals and investors for each accounting year if they wish for such exemption to apply. HMRC realizes that certain fund managers would not hold relevant information that is required under the new rules, and in some cases, will not be permitted by their fund constitution to reveal details of their investors. The provisions may cause problems for groups with minority investors, and restructuring would be required in such cases, as to enable the vehicles to profit from the exemption.

Conclusion

The new regime reflects the government's intention of levelling the playing fields between overseas and domestic investors in UK real estate. CGT's net extension may have made an indirect investment in real estate rather prohibitively inefficient for investors that are exempt, though the exemption and transparency election options for co-investment vehicles should bridge the result of the changes that this new regime would bring to the investors.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions