Tax insurance in the real estate sector

On the face of it, tax should be a pretty straightforward thing to deal with, either as an individual or as a business: the code is there in black and white, after all. But as anyone who had to file a personal return last month knows, the devil is in the detail.

When it comes to property companies or funds engaged in high-level and potentially multi-jurisdiction transactions, the complexity can be mind-boggling. It is for that reason property companies are increasingly seeking to insure themselves against any unexpected tax liabilities that may crop up as part of their activities. The fact that the UK tax authorities are increasingly litigious only adds to the concern.

“We continue to see the courts opining on an ever-growing number of cases as tax authorities become more litigious and [because of] the increased perception around perceived tax non-payment, which makes businesses increasingly concerned about tax risk,” says Alan Pratten, head of the mergers, acquisitions and tax team at Arthur J. Gallagher.

However, the fact is that there is no typical type of tax insurance policy - given the complexity of both the tax rules and many property companies’ corporate affairs, it would be worrying if there was. Rather, brokers like Arthur J. Gallagher look to provide bespoke solutions for clients. That said, there are a few typical situations in which property firms often find themselves that are particularly suited to a tax insurance solution.

Residency risk

The residency of a company or special-purpose vehicle (SPV) may look straightforward, but it only takes a minor error for a company resident in Jersey, for instance, to be deemed to be a UK tax resident. That is difficult enough for the company or SPV concerned to negotiate, but what about if it is seeking to sell an asset or company to another firm? Here, tax insurance can provide the buyer with greater confidence or, in some cases, allow the deal to take place.

In the event that the target is deemed to be UK resident - and therefore owes significant sums to HMRC - the insurance policy kicks in and guards against the buyer having to pay historical tax liabilities.

According to Dawn Bhoma, head of tax liability insurance at Neon Underwriting, a Lloyd’s syndicate: “Sellers often believe the risk of tax residence is low, but the buyer and its advisers often form a different view or are simply unwilling to take the risk of inheriting an entity that is in fact a UK taxpayer rather than an offshore vehicle.”

Restructuring

It is common practice in the property world for a company to reorganise its assets ahead of a sale. Say 20 properties are held within a separate entity, but the parent company only wishes to dispose of five. It might very sensibly create a new company, possibly incorporated offshore, to hold the assets. So far so straightforward.

However, what isn’t always clear is what that means in terms of what tax is owed on the assets and when. In these types of cases, tax insurance can provide confidence to both buyer and seller. A policy can be taken out that protects both the buyer and seller. Where the policy is held by both parties, the insurance premium may be allocated between the buyer and seller.

“We frequently see reorganisations ahead of a sale of part of a property portfolio held by a seller,” says Bhoma. “The buyer frequently refuses to take the risk such reorganisation would lead to tax liabilities for the target group it is buying. A common concern is the risk the reorganisation would lead to a stamp duty land tax charge due to the broad drafting of anti-avoidance rules.”

Trading or investment?

Under the current tax regime, assets bought for the purposes of holding for a medium- to long-term investment are treated differently to those acquired simply to be traded, with investments taxed far more favourably. That sounds simple enough, but life and taxes are seldom simple.

Say a property fund acquires an office building and fully intends to hold on to it, but then receives an offer it cannot refuse. The tax implications are notoriously complicated and unpredictable, predicated as they are largely on factors or case law. In this case, an insurance policy can provide reassurance that even if a tax authority challenges the tax treatment, the property firm has obtained certainty of tax treatment via the policy.

“In a buoyant UK property market… clients often receive unsolicited offers from a third party and decide to sell the asset earlier than originally intended,” says Bhoma. “This can give rise to a risk that the real estate should be treated for tax purposes as an asset that is trading in nature [and that] would bring the proceeds within the UK corporation tax net.”

The bottom line is the sheer complexity of tax law can introduce inherent uncertainly to a real estate transaction. At the same time, the fact that two parties may have very different interpretations of the various rules means that any potential tax issue can become a real barrier to completion. In such circumstances insurance may provide a solution and deliver genuine value to both buyer and seller. Matthew Bates at Arthur J. Gallagher advises: “The tax insurance market is still very specialist but it is highly innovative and capacity is growing. In the right circumstances, markets are keen to provide bespoke solutions for a range of specific tax risks.”

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