By Matthew Poole and Elizabeth Bradley, partners at Berwin Leighton Paisner
It has been a longstanding rule that offshore owners of UK real estate are not subject to UK capital gains tax on sale of commercial investment property.
This has seen property holding SPVs and JPUTs as the default choice of vehicle for overseas investors with onshore structures, on the whole, being avoided.
Following a surprise announcement in the Budget in late 2017, this beneficial tax treatment is set to be lost for many overseas investors in April 2019. The Government is proposing to tax overseas landlords on capital gains that accrue from April 2019 when disposing of investment property (both commercial and residential property).
In addition, and perhaps most problematically from the point of view of overseas investors, it intends to tax indirect disposals of property (so called disposals of “property rich” companies). This rule applies where an overseas investor holds 25% or more of a property rich company. Although the Government is consulting on certain aspects of the proposed changes, it has said that the scope, commencement date and other core features of the changes are already fixed.
Given that the Budget announcement took the form of a consultation paper, this leaves the industry in a state of flux without the full detail of available exemptions or reliefs. No doubt the industry will be lobbying hard to ensure investment keeps flowing into the UK in a post-Brexit world but it is difficult to predict how successful that will be. Institutional investors, in particular, will be hoping for targeted exemptions (which is currently contemplated in the consultation document).
What is clear is that the default option of investing via overseas SPVs is now under threat and investors are revisiting their options. One vehicle likely to be popular is a UK REIT.
UK REITs are exempt from UK corporation tax on rental profits and capital gains on disposal of investment properties. The regime is designed to mirror the tax effects of holding property directly and will, following the Budget announcements, be a very attractive alternative.
A REIT is UK tax resident and so, as an onshore investment vehicle, this is unlikely to fall foul of the court of public opinion. In the wake of the Paradise Papers, this will be welcome news to many.
One potential downside of a REIT is that some investors are subject to withholding tax at 20% on dividends which have benefited from exemption. REITs will be particularly attractive to UK registered pension funds, sovereign wealth funds and certain other UK tax exempt investors as they receive dividends from the REIT tax free (or obtain a refund from HMRC). In addition, most overseas investors will generally be able to reduce the rate of withholding on dividends to 15%.
Overseas investors currently pay UK income tax on UK rental income. However, with effect from April 2020, the Budget also confirmed that overseas corporate investors will pay corporation tax on rental income. This could result in further restrictions on the deductions for overseas investors when calculating their UK taxable profits, including the UK’s new corporate interest restriction rules and greater restrictions on the ability to use carried forward losses.
When considering this change, together with the proposals to tax overseas investors on direct and indirect disposals of investment properties, the UK is likely to have a less attractive tax regime for many investors than it did previously for many investors - although the REIT regime will offer a solution for some institutional investors. However, given this signifies a levelling of the playing field between UK and overseas investors and mirrors the approach of many other jurisdictions, the long-term impact on investment in UK property remains to be seen.