UK: Offshore Investment In UK Real Estate

Offshore investors in UK real estate face a range of tax obligations and charges to be managed. This briefing introduces some of the key tax aspects for investors using various offshore structures.

UK tax on gains

Gains realised by non-residents on the disposal of commercial (non-residential) UK real estate are still tax free for non-UK investors. Gains on the disposal of residential real estate by non-UK resident individuals and trusts are subject to tax at rates of 18% and/or 28%. Non-UK resident companies that are ‘narrowly controlled’ are subject to tax on such gains at 20% and/or 28%.

UK tax on income

Net rental income after deductions (see below) is chargeable to UK income tax and calculated on an accruals basis. The rate of tax depends on the type of investor. Offshore companies are subject to a 20% rate. Non-resident individuals and trusts are subject to progressive income tax rates of up to 45%.

Annual tax on enveloped dwellings

An annual tax can apply to dwellings worth over £2m (£1m from 6 April 2015, £500,000 from 6 April 2016) owned other than by individuals. Commercially let properties are generally exempt but exemption must be claimed. If exemption is not claimed, the liability depends on the valuation band of each dwelling and ranges from £3,500 (at a value of £500,000) to £143,750 (at values of £20m and over). Annual returns (including claims for exemption) and tax payments are generally due by 30 April.

Financing

Interest on loans incurred wholly and exclusively for a UK rental business is generally deductible in calculating taxable income. Restrictions apply where the rate charged is not at ‘arm’s length’ and on commercial terms. Interest payments may be subject to withholding at a rate of up to 20%. Structuring debt to take advantage of exemptions may be possible.

Tax depreciation

Generally, depreciation is not deductible from taxable income. Tax depreciation may be available for some fixtures, plant and machinery in commercial properties and certain multiple occupancy residential properties.

Determining what amounts can be claimed on a property acquisition or refurbishment project can be complex and, where previously claimed, the benefit of tax depreciation can be withdrawn on a disposal of the property. Specific advice on acquisitions and disposals is essential.

Repairs and renewals

In general, costs of repairing a property and items representing fixtures are allowable in calculating net rental income.

No deduction is available for replacing loose items of furniture but a wear and tear allowance of 10% of the rent less council tax and water rates may be claimed against the rental income from furnished residential property.

Losses

In general, unless properties are held by more than one entity, rental profits and losses across properties can be offset. Where there are excess losses in any year, these are carried forward and set against future rental profits.

Tax administration: non-resident landlord scheme

An annual tax return is required, assessing net rental profits for each tax year (6 April to the following 5 April). This return must be submitted by 31 January following the year of assessment. For example, the tax return for the tax year to 5 April 2015 must be submitted by 31 January 2016.

Advance agreement can be obtained for tax liabilities to be settled in three instalments payable on 31 January during the relevant tax year and on 31 July and 31 January following the tax year.

If an advance agreement is not obtained, the UK agent or the tenant will be obliged to withhold 20% of the rent payment and pay this to the tax authorities. Interest and penalties are generally payable in the event of late payment of tax or late submission of returns.

Value added tax

Generally, rents from residential property are exempt from VAT (currently 20%). Commercial property is generally exempt, but an election can be made to enable VAT to be charged. In making an election, thought needs to be given both to whether the seller has previously made an election and also to the VAT position of the tenant and that of any future purchaser.

New builds are subject to special rules.

Where a property is exempt, no VAT is chargeable on the rent or disposal consideration and VAT suffered cannot be reclaimed. However, where a formal ‘option to tax’ the property is made, VAT is chargeable on the rent and sales consideration but VAT suffered on expenses and on acquisition can be reclaimed. In certain situations, recoverability of VAT may be restricted.

Stamp duty land tax

SDLT is chargeable on the acquisition of UK property. A rate of 4% applies to commercial property acquired for consideration in excess of £500,000. Reduced rates apply to lower levels of consideration. Most residential property is charged at progressive rates of up to 12%. Residential property acquired for consideration in excess of £500,000 and owned other than by an individual can be charged at 15%.

Trading in land

Although gains on the disposal of some investment property can be exempt from UK tax, profits arising from a trading activity will generally be chargeable to UK tax. The UK tax authorities frequently challenge the status of offshore real estate investors where they consider trading activity to be undertaken.

For offshore companies dealing in real estate, UK corporation tax (or income tax where there is negligible UK activity and UK presence) can apply to their profits. From April 2015, both are charged at 20%. Offshore property development companies face a significant risk of their profits being subject to UK tax. Some planning to reduce this exposure may be possible.

Non-resident individuals and trusts are subject to income tax on both trading and development activities at progressive income tax rates of up to 45%.

Depending on where the trader is resident, the tax charge may be reduced or even eliminated through claims under appropriate double tax agreements.

Inheritance tax

On death, non-UK domiciled individuals are liable to IHT at a rate of 40% on the total value of their UK sited assets in excess of £325,000.

IHT exposure can often be reduced by owning property via an offshore company but this can give rise to a charge to the ATED and the 15% rate of SDLT on acquisition in the case of residential property.

How we can help

Cross border planning is complex. When correctly structured and implemented, there can be significant tax savings and cashflow advantages. Problems and higher tax charges can arise where proper advice has not been taken or structures have been incorrectly implemented and operated.

It is vital to take detailed tax advice on your plans before entering into a transaction to ensure that all UK tax obligations and charges are fully understood and managed.

Continual changes in tax law and practice mean that it is also important that existing structures are reviewed regularly to ensure that they remain tax-efficient and that all new compliance obligations are met.