Tax Considerations for Foreigners Investing in UK Real Estate
It is always helpful to get professional advice before proceeding with any investment. Tax advice is especially critical as taxes can make an otherwise attractive investment unattractive.
Ways in which an adviser can help –
- Advising on appropriate structures to avoid or minimise UK income tax, stamp duty land tax, VAT and inheritance tax
- Introducing appropriate UK advisers including legal advisers and letting management agents
- Establishing non-resident status with HM Revenue & Customs (HMRC)
- Arranging for income to be received gross
- Identifying and maximising tax deductible expenditures and capital allowances
- Submitting rental income returns to the HMRC and advising taxation payments due
Taxable elements need to be held separately from non-taxable elements. Typically, a non-UK company holds the property and another (typically, a UK company) to carry out the trading activity/development project. There is flexibility to superimpose whatever ownership structure is desired above the 'special purpose vehicle' that owns the property.
A UK resident landlord includes the property income on the annual tax return he makes to HMRC. Tax for a tax year (which in the UK runs from 6 April to 5 April) is sometimes paid in advance of filing the tax return. Payment is often made in two instalments on 31 January in the year and 31 July following the end of the year with sometimes a final payment on the following 31 January when the tax return is filed.
The treatment described above as applying to UK residents will normally be offered to any non-UK resident landlord who applies for it. However, if this treatment is not applied for (or if HMRC reject the application) a much harsher collection regime is imposed. Any managing agent must deduct and pay to the Revenue tax (at 20%) from rents net of any expenses that he pays on behalf of the landlord; a tenant who pays direct to the landlord must deduct tax at basic rate from all rent payments (unless the rent is less than £100 per week). Where tax deducted at source exceeds the true tax liability for the year it is possible to obtain repayment from the Inland Revenue by filing a tax return.
In principle, capital gains on commercial property made by a non-UK investor are not subject to tax. Therefore a non-UK entity, typically a company, should be used to hold the property. In order to benefit from this exemption, two key conditions need to be satisfied:
- The investor must not be engaged in 'trading' activity in relation to the property in question. Material redevelopment of the property or an intention at the time of purchase to sell the property within the first few years after acquisition would generally constitute trading. New rules mean that the profits of any development activity carried on in the UK are subject to tax in the UK.
- 'Management and control' of the non-UK entity must take place outside the UK. Therefore, while UK agents may take day-to-day decisions in the UK, any more strategic decisions must be taken outside the UK.
In general the UK only taxes individuals who are UK tax resident to capital gains tax. The main exception is on residential property. The UK tax loophole which allowed overseas investors and British Expats to avoid Capital Gains Tax (CGT) on the sale of residential property is now largely closed. The legislation allows three ways in which such gains can be taxed however in most cases tax will be charged based on the proceeds less the value at 5 April 2015 (or if the property was purchased after 5 April 2015 the cost at purchase).
Since the new rules came into force in April 2015 as a non-resident, when you sell a UK residential property you must tell the HMRC, even if you have no capital gains tax to declare. This also applies if you are selling, or have sold, your main residence.
Failure to correctly make a capital gains tax declaration to the HMRC within 30 days after conveyancing (transferring ownership of) your property is likely to result in a penalty – even if there is no capital gains tax to pay.
Non-resident companies have potentially been liable to UK capital gains tax on the disposal of UK residential property since 1 April 2013 if the property was valued at more than £2 million. That threshold has now dropped to £500,000 and covers most properties in the London area.
Disposals of commercial property by non-resident investors remain exempt from UK capital gains tax.
A word of caution is needed though: the tax rules summarised above assume that the investment in real estate is a genuine investment, made in order to generate rental income and with a view to long-term capital growth. If however property is acquired with the sole or main object of realising a profit on disposal, with or without any development of the property, any gain on disposal will normally be treated as income rather than as capital gains. It will therefore be subject to UK taxation as income and the beneficial treatment of capital gains referred to above will not be available.
UK income tax is charged on income from letting property situated in the UK regardless of the residence status of the landlord. This income is computed using ordinary accounting principles.
- Income and expenses can be taken into account on an accruals or an arising basis.
- Normal revenue expenses of earning income are tax deductible, including repairs, maintenance, insurance, management fees etc. It is important that detailed records, including invoices, are kept.
- Interest on a loan taken to acquire the property is in principle tax deductible though relief will be restricted to the basic rate of tax on a transitional basis from 6 April 2017 and phased in over 4 years.
- If the loan is taken from a connected party then relief will be restricted to the amount of interest that would have been paid in the open market. Even where capital is available it can often be tax efficient to borrow to invest in UK property.
- Capital expenditure (for example, on improvements to property as distinct from repairs and maintenance) is not deductible from rental income. It will instead be regarded as an additional cost to be taken into account when calculating any gain arising on a disposal of the property provided that it can be said to enhance the value of the property.
- No tax relief is available for depreciation or amortisation of the property itself. But in the case of commercial property, capital allowances (which are effectively depreciation allowances at a low standardised rate) are available for those elements of the property which meet the description of “plant and machinery”. This can be a valuable relief and the element attracting these allowances is normally negotiated (within statutory limits) at the time of purchase.
- All lettings carried on by a particular person are amalgamated for tax purposes and treated as a single business; thus if some properties are loss-making and others profitable, the set-off for tax purposes is made automatically.
- Non-UK-resident owners other than individuals (such as companies or trustees) pay tax on the profits computed at a flat rate of 20%. Individuals are liable at progressive rates rising from 20% to 45%, though many non-resident individuals (broadly, citizens of any state in the European Economic Area and certain Commonwealth countries) are entitled to claim personal allowances which give exemption from tax for the first £11,000 or so of profit.
- The income may also be subject to tax in the property owner’s home jurisdiction, although if there is a double Taxation Treaty with the UK (which is likely – the UK ‘s Treaties are among the most comprehensive in the world) the treaty will sometimes benefit the owner.
Gearing / Borrowing to Invest
Currently (subject to the commerciality test) all borrowing costs are deductible to reduce taxable profit, but changes targeted for April 2017 will limit the amount of deductible interest to 30% of the owner's EBITDA (broadly equivalent to income in the context of an SPV owning a single property let on a 'full repairing and insuring' (or in US terms, 'triple net') lease. This restriction is likely to apply equally to UK and non-UK owners and will bring the UK into line with a number of other 'competitor' markets.
It is not unusual for the seller's 'capital allowances' to be transferred, in whole or part, to the buyer. These are 'writing down' allowances against taxable profits in respect of historic capital investment in plant and machinery. The allowances are at the rate of 18% a year, with an 8% rate applying to 'integral features', and generally have effect on a 'reducing balance' basis. Each year the allowance is applied to the balance of expenditure after deduction of previous years' allowances, for example the 18% allowance is applied to 100% of the qualifying expenditure in the first year but to only 82% of the expenditure in the following year and so on. This means that around 75% of the expenditure is 'written down' over the first seven years.
On the sale of a property, the seller may well wish to retain any unused capital allowances. However, where the buyer would be able to benefit from them more than the seller, it may make more commercial sense for the seller to pass them to the buyer, generally for additional consideration.
Stamp duty land tax ('SDLT')
It is payable by the buyer. The purchase price will include any VAT, but fortunately this ‘tax on tax' is rarely levied
SDLT will be payable within 30 days after ‘substantial performance' of the transaction, which is usually completion.
If a non-UK propco (as opposed to the real estate it owns) is sold, no SDLT or stamp duty will be payable. If a UK propco is sold, stamp duty at 0.5% will be payable.
Value added tax ('VAT')
Supplies of land and buildings, such as freehold sales, leasing or renting, are normally exempt from VAT. This means that no VAT is payable, but the person making the supply cannot normally recover any of the VAT incurred on their own expenses.
However, you can opt to tax land. For the purposes of VAT, the term ‘land’ includes any buildings or structures permanently affixed to it. You don’t need to own the land in order to opt to tax. Once you have opted to tax all the supplies you make of your interest in the land or buildings will normally be standard rated, and you will normally be able to recover any VAT you incur in making those supplies.
VAT at 20% may be charged on the purchase price of commercial or mixed-use properties. This will be the case with new buildings and those where the seller has ‘opted to tax'. In cases where the sale is subject to VAT, there will be little practical alternative other than to ‘opt to tax'. That will often have the effect of making the sale itself VAT-free (and consequently mitigating the SDLT payable).
Where there is no immediate need to opt to tax, you should consider the best strategy for the property as a whole, taking into account future expenditure plans and the likely tenant-mix profile as some tenants will not be able to recover the VAT paid on rent.
Many of the costs incurred by investors in UK real estate will be liable to UK VAT at 20%, including legal, architects and survey fees, estate agents charges and other professional costs. Since the letting of residential accommodation is (in almost all cases) not a “taxable activity” for VAT purposes, the VAT suffered on those costs is not generally recoverable. Furthermore, VAT remains chargeable on services relating to UK land regardless of the place in which the recipient “belongs” for VAT purposes; the zero-rating available in respect of certain international services is not available where the services relate directly to UK land. Some associated services less directly connected with land (for example, accountancy fees) will usually be zero-rated where supplied to a non-resident.
Some commercial property is within the scope of VAT and it is normally possible to elect (on a property-by-property basis) to bring commercial (but not residential) properties within the VAT regime. We can advise on whether such an election is necessary, possible or desirable and to assist with relevant registrations. Residential and commercial developments and conversions may be affected by special rules on which we can also advise.
IHT: inheritance tax
Inheritance tax (which is normally payable only by individuals) combines some of the features of a gift tax, death duty and wealth tax. For most non-UK resident individual property investors, who have had no prior connection with the UK, only assets within the UK will be within its scope.
Although, with a 40% rate on death and a 20% rate on lifetime transfers, inheritance tax is at first sight a significant impost. There are many reliefs and exemptions which, properly used, can greatly reduce its impact. In particular:-
- the first £325,000 of transfers (on a seven-year rolling basis) are free of tax
- many transfers are “potentially exempt ” and create a charge to tax only if death follows within seven years of the date of the transfer
- the use of trusts may often effect substantial savings
From 6 April 2017, UK residential property is liable to UK inheritance tax regardless of how it is held.
High-value residential properties owned by companies
New rules were introduced in 2012 affecting the tax paid in relation to residential properties that are purchased and owned by companies, for properties with a value in excess of £2,000,000. The threshold was reduced to £1 million at 1 April 2015 and £500,000 at 1 April 2016. Where these rules apply, they can create an SDLT rate of up to 15% on purchase; an Annual Tax Charge of up to £218,200; and an uplifted CGT charge on sale.