28 March 2017

Proposed changes to tax treatment of non-uk resident companies

Significant changes are being proposed by the UK government to the way in which non-UK resident companies may be taxed. This will affect overseas companies that invest in UK real estate.

It was announced in the Autumn Statement in November 2016 that the government was considering moving non-UK companies into the corporation tax regime (which already applies to UK resident companies), and out of the income tax regime which applies at present. A consultation document has now been published which sets out more information about what is proposed and asks for comments.

Why are these changes being proposed?

For UK resident companies, more restrictive provisions are being brought into force from 1 April 2017 which restrict the amount of interest that can be deducted by such companies against their profits and also the use of losses. The government would like these provisions to apply to non-UK resident companies. It believes that it is easier to achieve this by bringing those companies into the corporation tax net rather than trying to adapt the new deductibility regime to fit within the existing income tax rules. This is particularly relevant to non-UK resident companies which own investment properties as the income tax rules which permit interest deductions on loans made to those companies are generally less restrictive than the new interest deductibility rules which apply to UK companies.

The focus of the consultation is therefore to be on how income from UK real estate held by a non-UK resident company can be brought into the corporation tax regime. It is also proposed that non-resident capital gains tax (NRCGT) which applies to residential property should also come within the corporation tax regime at the same time. However, there is no current proposal to make UK commercial real estate held by non-UK resident companies as an investment subject to UK tax on chargeable gains. It is also apparently not proposed to change any of the withholding tax regime provisions which can apply to payments of interest by non-UK resident companies.

How these changes could impact the transactions of non-UK resident companies

Complicated transitional provisions would need to be introduced to deal with non-UK resident companies moving from the income tax regime into the corporation tax regime. It is currently proposed that the switch would take place on 6 April in the financial year in which the changes came into effect, with no particular year for the change-over yet having been proposed. Further thought will need to be given as to what happens in relation to capital allowances on fixed plant and machinery held by the relevant company; it is expected that the aim would be to prevent the creation of balancing allowances or charges at the point when the new regime comes into effect.

Extensive transitional provisions would be needed to deal with profits from loan relationships and derivative contracts to ensure that amounts were not taxed or relieved twice as companies moved from one regime to another. The Government proposes that any unused losses from the UK property business which were still in existence on 5 April of the relevant year would be computed under income tax principles. Assuming that the income tax loss had been obtained on a commercial basis, it is expected that this loss could be carried forward into the corporation tax regime as what will be known as "income tax property losses". It is currently proposed that these losses would be carried forward against the continuing UK property business but could not be surrendered as group relief or set against other corporation tax profits of a non-resident company. If the property business ceased, then the income tax property losses would be extinguished for tax purposes. The income tax property losses would not be restricted under the corporation tax loss reform rules which are discussed further below.

Could your company benefit from a £2m exemption?

Whereas for non-UK resident companies interest payable is treated as a deduction from rent, for UK resident companies loans are dealt with in a separate regime (the loan relationship rules) and the rental profits are, initially, calculated without a deduction for interest although the profits chargeable to corporate tax are reduced by any "deficit" that has been calculated under the loan relationship rules. The new corporation tax rules for corporate interest expenses which for UK companies are taking effect from 1 April 2017 would start to apply to non-UK resident companies if they are brought into the corporation tax regime. Currently there is a de minimis exemption from these rules for £2m net interest expense which can be shared by the worldwide group so that if the non-UK resident company had no other group companies, it could benefit from the £2m exemption from a restriction on interest deductibility. It is also possible that the non-UK resident company would benefit from exemptions in respect of its third party debt under the public infrastructure rules where property is let out to third parties. However, it is likely that significant analysis relating to any required restructuring would need to be carried out by non-UK resident companies as a result of the proposed changes (in particular if there was no or limited grandfathering in relation to existing debt).

What is happening about carried forward losses?

Further provisions will need to be considered relating to what happens in relation to losses which are being carried forward in respect of the non-UK resident companies' existing property businesses. In future, under the new regime, the corporation tax loss rules would apply. They are being introduced in the Finance Bill 2017 so that, in future, only 50% of the profits recognised by a company can be sheltered by corporation tax losses carried forward from previous accounting periods, although there will be more flexibility in relation to the surrender of losses than there used to be in the past.

HMRC see further complications arising if the non-resident company not only holds investment property but also has other activities. Where this is the case they would want to limit the deductibility of management expenses so that the deduction only relates to expenditure incurred for the purposes of managing the part of the investment property business which has a UK source and is therefore within the corporation tax regime.

What is next and when can non-UK resident companies learn more?

Responses to the consultation exercise are sought by the 9 June 2017. We are taking part in this process.

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