The impact of the 2019 changes to non resident CGT on UK property

In line with the global trend over the last decade to seek out additional sources of tax, particularly from overseas, the UK government continues to target UK non-residents for tax revenue. The most recent change is a widening of the types of UK real estate that are subject to capital gains tax in the hands of UK non-residents. Xavier takes a look at the wider context of the new rules that took effect in April 2019 and gives his thoughts on what might come next.

What is the objective of the new rules?

The government’s stated intention was to level the playing field between domestic and overseas investors in UK property. The government had already taken steps to do this in relation to residential property: in 2017, non-UK domiciled individuals became subject to inheritance tax on indirectly-owned residential property; and since 2015 non-residents have been subject to capital gains tax on disposals of residential property.

The new rules do two things:

1. they extend the tax on residential property to gains made indirectly – on disposals of interests in property-holding companies; and
2. they bring into charge direct and indirect disposals of commercial property.

This may be seen as fair and reasonable, levelling the playing field between UK and overseas investors. But it is part of a shift over the last few years away from a policy which was very deliberately aimed at encouraging inward investment and migration, towards a system which essentially looks to treat everyone in the same way. This may be in line with the prevailing mood, particularly with increasing media focus on tax avoidance and even tax mitigation.

The challenge will be to ensure that these new policies do not deter overseas investment into the UK: investment which for many years has generated a great deal of growth.

To put things in context, the changes this year are the latest of a series of reforms that have targeted property as a source of taxation. Not just bringing non-residents into capital gains tax, and bringing non-domiciled individuals within the scope of inheritance tax, but also a series of changes to stamp duty land tax (SDLT) which have increased significantly the cost of acquiring property.

Bricks and mortar have clearly been targeted as a source of tax revenue, and reforms have been a relatively easy sell to the public, in the context of historic double-digit house price growth and press attention on tax avoidance. Combined with uncertainty over Brexit, the result has been a marked slowdown in residential property activity. It will be interesting to see to what extent that happens now in relation to commercial property.

What are the new rules?

In essence, everyone will now pay tax on UK property gains. Non-residents will be subject to tax on all UK real estate gains:

• direct disposals of directly-held property; and
• indirect disposals of propertyrich companies – i.e. disposals of interests in companies that derive 75% or more of their value from UK real estate.

Tax is charged on persons who hold at least 25% of a property-rich company (aggregated with related parties).

There is rebasing, as we’ve seen in the past with non-resident CGT:

• For disposals that weren’t previously subject to tax, property values are re-based to 5 April 2019. This includes indirect disposals of residential property, and all disposals of commercial property.
• Residential property that was previously subject to non-resident capital gains tax continues to be rebased to 5 April 2015.

The rates of tax:

• Individuals are subject to capital gains tax at the following rates:
  • Residential property at 28%
  • Commercial property at 20%
• Companies are subject to corporation tax at 19%, reducing to 17% in April 2020.

ATED-related CGT, which was introduced in 2013, has been repealed.

There are some exemptions:

• A trading exemption for sales of property-trading companies available to corporate and noncorporate shareholders. Relief is available where up to 10% of the assets in a property - trading company are non-trading.
• The substantial shareholding exemption will continue to apply for sales of trading companies by other holding companies. This is only available to corporate shareholders and there is a 20% threshold for non-trading elements. There is no trading requirements if the company is owned by a qualifying institutional investor.
• Funds and Jersey property unit trusts (JPUTs) have various elections, exemptions available that aim to prevent double taxation. Previously the scope for taxation occurred both at the level of the fund when it disposed of its investment and at the level of the investor when the investor disposed of their units in the fund.
• Funds (ie pension schemes, collective investments schemes) can elect to not be subject to tax at fund level
  1. Unit trusts (including JPUTs) can make a transparency election so that gains are treated as arising to the underlying investors

So what next?

There are some certainties. We know that, in 2020:

• rental income for non UK companies will become subject to corporation tax rather than income tax;
• for large property-holding companies with debt where the interest exceeds £2 million, the ability to deduct interest from taxable profits will be restricted.

Moving into more speculative territory as to what else might happen: the direction of travel seems to be to remove all of the tax benefits that were previously available to non-resident investors. If that is the case, what is left to align? The two remaining anomalies are:

• non-residents can still limit their income tax liability on rental income to a flat rate of 20% - by interposing a non-resident company; and
• non-domiciled individuals are not currently subject to inheritance tax on UK commercial property held through a holding company.

Could this change? Only time will tell.

What about SDLT on transfers of shares in property holding companies? Ironically, the residential property reforms started in 2013, with the so-called three-pronged attack launched by the then chancellor, George Osborne, with the purpose of stopping people saving SDLT by selling shares in property-holding companies. Yet, it’s still possible to do.

Beyond taxation. There have been many newspaper articles about the ability of the super-rich to reduce their exposure to inheritance tax through tax loopholes. This scrutiny is part of an established trend and a mood that will not go away soon. Ironically, the so-called loopholes are the result of deliberate government policy such as business property relief, and the ability to make lifetime gifts under the seven year rule (which may now be reduced to a five-year rule), all accepted by successive governments. Governments respond to the public mood as much as they contribute to it: if one looks at the reforms to enveloped properties in 2013, it’s well known that the changes stemmed from papers leaked to the government and drawing attention to the apparent widespread practice of trading shares in property owning companies to avoid tax, which in fact was the case in only a tiny minority of cases.

On to the good news...

There’s every reason to be positive. Whilst investing in UK property isn’t the tax-free jackpot that it used to be (the days when non-residents could invest in UK property, pay no capital gains tax, no inheritance tax, and income tax at 20%, are gone), the impact of the changes have not been as negative as originally predicted. There was great concern that the reforms would have a significant impact on economic growth, but the evidence gives us reason for optimism.

Whilst economic growth has slowed, there are many reasons behind that, and tax reform is certainly not the primary cause. We are still seeing inward investment, we are still seeing people moving to UK (granted, it’s slower), but wealthy people are still coming to the UK and those pull factors still apply.

Despite the current turmoil in Westminster, the UK is still seen as having a stable political framework. London remains one of the best cities in which to do business. For people who are thinking about where they are going to move to, equivalent alternatives are limited. Absent “pure” tax havens (the Bahamas, Jersey, with all their drawbacks in the real world), what are the onshore options? Italy’s non-dom regime is quite attractive at the moment, but it lacks the political and business factors. Switzerland perhaps, but that’s a very expensive place to live. The US is of course a big competitor. The UK remains a hugely attractive place to live and do businesses, our non-dom regime still keeps us competitive. So, for as long as we maintain those pull factors, tax changes can be absorbed and the UK will continue to be a hugely welcoming place for wealthy people to invest and live.