In recent years the UK has implemented various tax-code changes to eliminate some of the traditional tax benefits associated with offshore holdings. Starting in April of this year, for example, the UK implemented a 20 percent tax on income from intellectual property held by non-UK resident entities in low-tax jurisdictions.
Another rule change — and the subject of this post — involves the practise of owning UK property through an offshore investment vehicle such as a company or trust. This is known as "enveloping" a property, as "the ownership sits within a corporate 'wrapper' or 'envelope'."
The new rules seek to eliminate the longstanding advantages of this practise. This post summarizes the UK rules changes and explains why many shareholders of UK companies are now considering "de-enveloping" properties by transferring them to personal ownership.
In 2012, the UK government announced a new tax program to address the perceived advantages associated with owning high-value UK residential property through companies or trusts. The program introduced a tax charge known as the Annual Tax on Enveloped Dwellings, or ATED. ATED initially applied to properties valued in excess of 2,000,000 pounds, but for tax returns from 2016 to 2017 onwards, the threshold has been reduced to 500,000 pounds.
Given the relatively low ATED threshold and other factors, many companies and trusts that own UK real estate are looking to extract affected properties from their current investment structures in a process known as de-enveloping.
Those looking to de-envelope a UK residential property from a company have a number of options. The most common method is to purchase the property from the investment vehicle (such as a company or trust) or distribute the property as an asset, sometimes referred to as "dividend in specie."
When deciding whether to purchase a property from a company or make a distribution in specie, you'll have to consider a number of factors. You'll need to take into account, for example, the liquidity of the individual(s) who wish to take direct ownership of the property, along with the company's financial position, including the amount of debt on the property.
This post primarily addresses de-enveloping a UK residential property from a company. That said, the methods for extracting properties from trusts are broadly analogous to the methods for extracting properties from companies.
Accounting for capital gains tax when de-enveloping a property
Traditionally, companies and individuals that were resident outside the UK were not subject to UK tax. However, the 2012 reforms have placed all ATED property within the scope of UK capital gains tax (CGT), regardless of the owner's residence status. These rules extend to all UK real estate effective April 2019.
The changes can complicate the transfer of properties to shareholders, as UK law states that transactions between companies and their shareholders are taxed as if they have taken place at market value. This means that a CGT charge may arise even if no money changes hands, regardless of the notional value of the transaction (including a transaction where no money changes hands).
To ensure these new CGT rules are followed, the UK now requires a company de-enveloping a property to submit a CGT return and make a CGT payment within 30 days of the real estate transaction. In addition, the person acquiring the property must submit a stamp-duty land tax (SDLT) return and make any associated tax payment within 14 days of the transaction date.
Both companies and shareholders in this situation should therefore calculate any CGT and SDLT liability well before the transaction date, since there is a narrow window for reporting and paying any CGT and SDLT.
Depending on the residence status of the individual(s) taking direct ownership of a property from a company in which they have shares, there may be additional personal tax consequences as a result of home-country legislation. These risks should also be reviewed well in advance of the de-enveloping transaction date.
Other tax considerations in a de-enveloping by purchase
In a de-enveloping by purchase, the company that owns the property must register either a gain or loss in its accounts, depending on the sale price and applicable accounting rules.
If the property is sold for less than market value, the "discount" to the market price may need to be treated as a deemed dividend. CGT will be chargeable to the company based on the difference between the property's market value and its original cost, and must be paid within 30 days.
The purchaser will be liable to SDLT on the amount paid for the property, with any amount due within 14 days.
Depending on where the purchaser is tax resident (and on home-country legislation), any deemed distribution received may need to be declared as well.
Other tax considerations when distributing property as an asset
When a property is distributed as an asset — or dividend in specie — the company must comply with local distribution rules, including undertaking any capital reduction to create sufficient distributable reserves when transferring the property.
Distributing property as an asset is considered disposal for CGT purposes. As a result, CGT will be calculated on the difference between the property's market value and its original cost, with any CGT payable within 30 days. Any distribution will need to comply with local corporate governance laws and accounting rules, including the preparation of relevant board resolutions and minutes.
SDLT may be chargeable in certain circumstances, for example in cases where the distribution is a return of capital or when there's a mortgage on the property. Any SDLT amounts due must be paid within 14 days of the distribution.
Depending on where the recipient of the distribution is tax resident (and on home-country legislation), a dividend may need to be declared on the recipient's personal tax return.
The tax consequences of transferring ownership of properties from companies to individuals are complex, and errors are nearly always costly and time-consuming. This post has concentrated on the direct tax implications of de-enveloping UK residential properties, particularly for companies and individuals that don't reside in the UK, and who can no longer rely on non-residence as protection from UK tax obligations. There are other important considerations I haven't discussed, such as those related to indirect tax (applicable to certain commercial property), home-country tax implications, and related commercial considerations (including exchange rates and loan covenants).
As usual, companies and individuals should conduct due diligence well in advance of making a de-enveloping transaction, and seek expert advice to ensure they understand all their available options and related risks and opportunities.
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.