Article by Verfides
UK real estate, particularly prime property in London, has always attracted significant international investment. Now, as the UK property emerges from recession, there are renewed opportunities to benefit from significant capital growth and healthy rental streams.
Investment in UK real estate must be structured carefully in order to mitigate UK tax at source on income, gains and transactions. Taxes may be levied on rents, development profits and capital gains, and there also stamp taxes and inheritance taxes to consider.
We consider a number of common investment scenarios below, and particular structures which will help to shelter the investments from UK tax.
It should be noted that this article focuses on commercial property purchases and the purchase of residential properties worth under £2 million. Major tax changes are due to come into force from April 2013 with regard to residential properties valued over £2 million (termed 'Shigh value residential property') held or acquired by non-natural persons. Please see our separate article on this matter or contact us for further details.
Individual purchase of one or more UK properties
Many of our clients are simply looking to purchase a single UK property, perhaps to use as a London base, whilst others wish to develop a portfolio of properties under single ultimate ownership. Many of these properties will be rented on the open market.
It should be mentioned at the outset that a non-resident is not subject to UK tax on capital gains, even where derived from UK assets. This includes a non-resident individual, partnership or company. Investment properties can therefore be sold on at a gain in the future without tax considerations (although note below that there may be a different treatment where a property is acquired, developed and sold on in a relatively short period of time). Note that this capital gains exemption is likely to be abolished from April 2013 but only for high value residential property held by certain non-natural persons.
A private use property will not be subject to any taxes on (deemed) income in the UK whilst the owners remain non-resident for UK tax purposes. On the other hand, profits deriving from UK rental receipts are taxable in the UK in all cases, on the following basis:
- Non-resident individual owner: at a rate of between 20% and 50% on income depending on the level of profits
- UK resident company: 24% on income and gains
- Non-resident company: 20% on income only
It can be seen from the above that it is preferable for the investment(s) to be made through a non-resident company, preferably in a low tax jurisdiction.
An overseas landlord is required to register with HMRC under the Non-Resident Landlord Scheme. Strictly, 20% tax must be withheld by the tenant or agent from net rents. However, approval can be obtained from HMRC for rents to paid gross, providing an annual tax return is filed and tax paid on time.
In order to reduce net rents chargeable to UK tax, it is often advisable for the shareholder to loan the company funds to purchase the property. Interest is then paid as an allowable deduction from rents. The loan should be secured on the property in order to obtain a maximum deduction on arm's length principles under the UK transfer pricing legislation. There must also be a commercial level of equity contribution and a suitable interest rate.
Planning should be undertaken to ensure the interest paid has a non-UK source, to avoid UK withholding tax (the rules relating to the source of interest for withholding tax purposes are currently subject to a consultation process with a view to some amendments).
In many cases the shareholder advancing the loan will be a second BVI company which will not be chargeable to tax on its interest receipts.
A further advantage in using a non-UK company is that it eliminates exposure to UK inheritance tax (IHT). UK IHT is levied on all UK-situate assets on the death of the owner, regardless of residence or domicile status. The tax is levied at a rate of 40% above a threshold value of £325,000. By using a non-UK company (note that the requirement is for a non-UK incorporated company, not merely a non-UK resident one) the assets comprise in the estate on death are shares in a foreign company rather than the UK real estate. Such shares are exempt from IHT for a non-UK domiciliary.
Classic UK property ownership structure:
Collective Investment Schemes for UK Real Estate
Although there are many individual private investors in London real estate, a collective investment scheme or fund is often required to generate sufficient purchasing power and / or leverage. As such they have become popular over the last ten years at both the public and private level. Note that such schemes may be subject to new charges from April 2013 if they invest in high value residential property and further advice should be sought in this regard.
Authorised Funds with Diversity of Ownership
At the public level, the UK introduced the Real Estate Investment Trust (REIT) in 2006. The REIT is a listed fund undertaking a property rental business and is thus applicable to both retail and institutional investors. The advantage of a REIT is that income and gains are not taxed at REIT level, although withholding taxes often apply on distributions to investors and there is an annual requirement to distribute up to 90% of property income profits. Due to the listing requirement a REIT is not suitable in structuring a private property fund.
As an alternative to the REIT, the Property Authorised Investment Fund (PAIF) regime was introduced to allow a tax-favoured property fund to be formed without a listing requirement. The tax benefits are broadly similar to the REIT, but again withholding taxes will often be levied on distributions from the fund. Despite the reduced scale of the PAIF, there is still a rigorous 'Sdiversity of ownership' requirement, meaning that smaller groups of investors will still not be able to benefit.
Authorised UK real estate fund:
Private Property Fund Vehicles
As a result of these restrictions Verfides has been active in developing non-UK based fund structures which are able to provide similar, or more extensive, tax advantages without the ownership restrictions placed on UK-based schemes.
In particular, the Cyprus Private Fund or ICIS is ideally suited as a private collective investment scheme for UK property. It combines the benefits of an EU-regulated fund which, when effectively structured, can achieve very low tax UK and overseas tax leakage. Cyprus funds are a good on-shore alternative to the traditional unit trusts established in Jersey, Guernsey or the Isle of Man, or may be combined with a traditional tax-efficient offshore investment structure.
Carefully structured financing, in accordance with UK transfer pricing principles, can reduce the UK tax charge significantly, whilst the profits received in Cyprus as dividends are not subject to tax. Dividends and / or interest can then be paid out to the ultimate investors free of withholding tax.
Cyprus Private Fund for UK Rentals:
Simple Co-Ownership Structures
A group of investors looking to come together to invest in a particular project may consider forming a UK Limited Partnership, typically where they are not looking to attract further funds in the future from other investors. Each partner contributes funds to the partnership and takes an interest in the underlying partnership assets and income as a limited partner. As a limited partner, liability is limited to the sum invested and undrawn profits.
The partnership is transparent for UK tax purposes so that only income (not gains under current rules) arising in the UK will be taxable on the members. An unlimited partner, often an offshore company, is appointed to manage the assets but has no interest in underlying income or capital.
The advantage of a limited partnership structure is its flexibility, in that relations between partners are governed by a partnership agreement which can be altered at any time by agreement. The disadvantage is that the structure is relatively illiquid, unlike a fund where units or shares may be traded more easily. Care must be taken in structuring borrowings to reduce the UK tax charge, as there are restrictions applicable to partnership structures.
Limited Partnership Structure:
Planning for UK Property Developments
The UK property development market is also picking up again and has been a popular investment choice for non-residents over the last 10 years.
A site is typically acquired, developed and then sold on at a profit in a relatively short period of time. Such an activity is considered a trading activity in the UK, subject to income taxes on trading profits. As such the amount of tax at stake is often considerable and careful planning is required.
Short-term developments may avoid UK tax altogether when the developer is a company based in a jurisdiction with which the UK has a suitable tax treaty. The treaty should state that a building site does not constitute a permanent establishment (PE) until the expiry of 12 months. This has typically involved the use of companies in Jersey, Guernsey or the Isle of Man.
Most developments last longer than 12 months and therefore a PE in the UK is unavoidable. In such cases, planning can be undertaken to ensure that only profits directly attributable to the PE come into charge to UK tax. With careful planning, significant pre-development profits, such as increases in value on securing planning permission, can be kept out of the UK tax net.
Such an offshore development vehicle is particularly attractive when combined with a Cyprus private fund, allowing a bespoke group of investors to collectively finance a development. There will be no further tax on the dividends received in Cyprus from the Jersey company, as they derive from a trading activity.
UK Property Development Structure:
UK real estate continues to represent an excellent investment opportunity for non-residents. Structured carefully, the UK and international tax leakage can be minimised. There are also opportunities for collective investment in UK property within tax-efficient structures. Where an investment has been or will be made into residential property worth in excess of £2 million, further advice should be sought in the light of proposals to introduce further tax charges from April 2013.
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.