Capital gains tax on UK property for non-resident investors: implications for offshore real estate structures
15 January 2019
From April 2019 gains made by non-residents on all types of UK property will become, for the first time, subject to UK tax. This briefing provides an overview of the new rules, and explores the relevance for offshore-based structures holding UK real estate.
Historically, non-UK residents have not been subject to UK tax on capital gains made on UK property. In 2015 the law was changed such that, with certain exceptions, non-UK residents became subject to UK tax on gains made on UK residential property. The UK government has now put forward legislation meaning that, from April 2019, non-UK residents will be subject to UK tax on all gains made on all types of UK property, including UK commercial property.
Overview of the new rules
The non-resident CGT rules provide for the payment of UK tax by non-UK resident investors on gains made on all types of UK real estate. Accordingly, non-UK residents will be liable to pay UK tax on gains made on disposals of any directly-held property, whether residential property or commercial land and buildings (direct gains).
In addition, non-UK residents will pay UK tax on gains made on a disposal of an interest in an entity that is 'UK property-rich', i.e. which derives 75% or more of its value from UK real estate (indirect gains). Tax will be chargeable on gains made by investors on the sale of interests in companies, non-corporate vehicles and collective investment vehicles (CIVs), but most partnerships will continue to be treated as transparent for tax purposes.
For the indirect disposal rules to apply, an investor must generally have at least a 25% interest in the entity that is being sold. That is, the investor will be subject to UK tax on gains if they hold 25% or more of the entity, but will not if their interest is below this level. Interests of 'connected persons' are, however, combined for the purposes of determining a vendor's interest in an entity.
During the extensive consultation process which preceded the publication of the new rules, concerns were raised by the property industry about the potential, under the revised rules, for multiple layers of taxation to be suffered within investment structures due to the indirect disposal rules. For example, the same gains could be subject to tax both at the level of one or more vehicles within a property-holding structure, as well as in the hands of the underlying investors. In addition, the rules have the potential for certain tax exempt investors (such as pension funds) to become subject to tax on their property investments (if, despite such investors being tax exempt, tax would nonetheless be payable at the level of the investment vehicle through which they invest).
In light of this, two new elective regimes have been developed to provide relief for collective investment vehicles (CIVs), both of which can be available to offshore property-holding vehicles.
Collective Investment Vehicles (CIVs)
The two elective regimes are available to 'collective investment vehicles' (CIVs) as defined under the new rules. Broadly speaking, the elective regimes may be spoken of as being available to 'funds', but in practice they will be available to many closely-held club investment and joint venture arrangements, as well as certain proprietary holding vehicles which meet the definition of a CIV. That definition includes collective investment schemes, authorised investment funds and REITs (whether UK or overseas).
If classified as a CIV the 25% test for indirect disposals is disapplied such that, in principle, an investor in a CIV would potentially be subject to tax on indirect gains irrespective of the extent of the investor's interest in the CIV, as well as the CIV being subject to tax. However, the two elective regimes change this default position.
The transparency regime
Certain CIVs can elect to be treated as transparent for tax purposes.
The conditions are that the CIV must be non-UK resident (such as in an offshore jurisdiction), must be income tax transparent (such as a partnership, or a Jersey property unit trust (JPUT) established as a 'Baker trust') and UK property-rich. All investors in the CIV must consent to the making of the transparency election, which election must be made by 5 April 2020 for existing structures, or within 12 months for new structures.
If elected as transparent, the entity will be treated as a transparent partnership and accordingly capital gains tax will not be payable by the CIV, but by the investors as though they held the asset directly (if the investors are taxable: exempt investors, such as a pension fund, will retain their exemption). For multi-layered structures to be treated as transparent, elections would need to be made in respect of each subsidiary entity. The CIV will have to file annual UK partnership tax returns disclosing details of investors and any disposals.
Opting for the transparency regime avoids double taxation, and ensures that those structuring through a transparent entity (whether a fund, club or joint venture arrangement or proprietary holding structure) are not disadvantaged as compared with those holding assets directly. Importantly, the regime means that offshore tax transparent structures (such as JPUTs) will continue to provide a well-recognised and tax efficient holding structure for UK property.
The exemption regime
Certain CIVs can elect to be exempt from capital gains tax.
The conditions are that the CIV must be (i) non-UK resident (such as in an offshore jurisdiction) or (ii) a company owned at least 99% by a CIV that is a partnership or a Co-ownership Authorised Contractual Scheme, and UK property-rich. The entity must meet diversity of ownership rules or 'non-close' conditions. The election for exemption is made by the fund manager, rather than the investors directly. The election can be made from 6 April 2019, and can have up to 12 months' retroactive effect.
If electing to be exempt, the entity will be treated as exempt from UK tax on direct and indirect disposals, and entities owned by the CIV will be similarly exempt. Accordingly the 'fund' and its subsidiaries are exempt from capital gains tax. However, capital gains tax is applicable at the investor level, such that capital gains tax will be payable by the investor on any gains made on the sale of their interests in the fund (unless the investor is exempt, such as a pension fund). The fund manager will have to make annual filings disclosing details of the CIV and its group, and disposals within the group, as well as details of the CIV investors and disposals by those investors.
Opting for the exemption regime means that any gains made within the fund will be untaxed, and realised (untaxed) profits can be reinvested within the fund structure, and it is only when investors sell their interest that tax on accumulated gains may be payable. Importantly, the exemption regime is available to non-UK resident CIVs (such as an offshore company meeting the CIV criteria), meaning that offshore companies remain a sensible option for structuring UK-focused real estate funds.
Implications for offshore
Offshore jurisdictions provide long-established platforms for international investment, acting as tried and tested hubs for the structuring of investment into UK real estate. The changes being introduced by the UK government are designed to 'level the playing field' in terms of taxation of gains between non-resident and UK-based investors in UK real estate, and accordingly international investors will now have to make an assessment in respect of the implications of UK capital gains taxation for their investments in UK real estate. Appropriate tax advice will be required, as elections may need to be made so as to avoid any unnecessary taxation.
So far as offshore structures are concerned, the accommodation provided within the new rules for non-UK structures means that investors remain free to choose to structure their UK property investments through offshore jurisdictions, and where elections are made there will be no question of double taxation. In particular, it is envisaged that the new rules may encourage investors to utilise tax transparent structures, opting for the transparency regime - as such, the well-established JPUT (or GPUT) may prove to be a vehicle of choice. The potential for multiple levels of tax may also lead to a simplification or 'de-layering' of property holding structures. Private funds, established under the fast and flexible regulatory regimes available offshore, may be an attractive option for those structuring UK-focused real estate funds, opting for the exemption regime.
In overview, it is clear that investors will continue to be able to take advantage of the wealth of expertise and experience available offshore in terms of the establishment and administration of property holding structures, and the legal and regulatory flexibility available to offshore vehicles. As such, there remains a compelling case for using offshore jurisdictions as a platform for UK real estate investment.