Taxing times for UK real estate investments: What next for funds and investors?
Are UK real estate investments about to lose their shine?
Further to the announcement of an unexpected reform to the property tax regime by the UK Chancellor of the Exchequer in the Autumn Budget 2017, there are signs that foreign investors in UK real estate investments may be losing their appetite. A recent survey of leading international real estate conducted by Coleman Parkes Research revealed that 65% of real estate investors predict extra uncertainty well into 2020 and beyond, caused by the proposed tax changes, coupled with Brexit. Furthermore, in 2018 62% of investors believe that there will be lower allocations to UK real estate.
So what is the objective of this reform which is due to take effect in April 2019? Without any warning or prior consultation, the UK Chancellor of the Exchequer, the Rt. Hon. Philip Hammond MP, announced a property tax reform on 22 November 2017 which has the broad aim of aligning the tax treatment of non-residents with that of residents, on the basis that the UK has been too generous for too long as compared to other jurisdictions, and is now set to adopt a stricter approach going forward.
While the purpose and direction of government policy are already clear, the UK Government launched a consultation exercise at the time of the announcement, which ran until February 2018, to obtain feedback on the details of some of its proposals. The main changes proposed are as follows:
- As from April 2019, the Government proposes to bring non-UK residents within the scope of UK corporation tax or capital gains tax (CGT) on gains arising on the disposal of UK commercial property;
- There will be a single unified regime applicable to all investors, whether resident or non-resident;
- Interests in UK commercial properties held by non-residents from April 2019 will be subject to a valuation “rebasing” (so historic gains will not be subject to the tax);
- The new rules will be applicable to both the direct disposal of UK property and also the disposal of indirect interests in UK property. This will cover the sale of a "property rich" company by a person (or connected persons) who have an interest of at least 25% in that company (the ownership test). A "property rich" company is defined as one where 75% or more of its gross value at disposal is represented by UK property;
- There will be a new reporting requirement for the non-resident investor’s UK advisers in the case of indirect disposals, who will be required to report a sale to the UK tax authority (HMRC) within a 60 day deadline.
What will be the impact on real estate investments and structuring? Based on the consultation document, it seems that there will be an impact both at the fund and investor level. At the fund level, Osborne Clarke has identified that funds that are exempt from gains on the disposal of UK commercial property only by reason of not being UK tax resident would be brought in the scope of UK tax, which is likely to affect Jersey Property Unit Trust (JPUT) structures for example. Eversheds Sutherland International has also highlighted that it will be important to understand what exemptions will be allowed, not just for the investors themselves, but also in calculating the impact on the vehicle itself, particularly if it has what would otherwise be tax exempt investors. It also notes that on the residential side a major change will be the abolition of the ‘widely-held’ rule which currently exempts many offshore funds and companies from non-resident Capital Gains Tax. It seems that the new exemption will be narrower in scope and so some funds may not qualify or not to the same extent. It also remains to be seen how the new proposals will interact with previously published draft regulation on changes to the Capital Gains Tax treatment of certain offshore funds (including some JPUTs and contractual funds) which were circulated in March 2017.
One bit of good news is that Collective Investment Vehicles (CIVs) which currently enjoy tax advantages (such as Real Estate Investment Trusts (REITs), Property Authorised Investment Funds (PAIFs), Exempt Unauthorised Unit Trusts (EUUTs) and Authorised Unit Trusts (AUTs)) will not be immediately affected and these may become even more appealing prospects for international investors. However, the consultation document states that the impact of the rules on non-residents investing through such funds as well as on the funds industry as a whole needs to be carefully considered. It is quite possible, therefore, that the rules of such schemes could be revisited. Even now, investors should take note that an ‘anti-forestalling’ rule will apply to certain arrangements entered into after the publication of the consultation paper, which may seek to exploit provisions in some tax treaties, and a Targeted Anti-Avoidance Rule will come into force in April 2019.
In terms of the impact of the new rules at the investor level, Osborne Clarke predicts that the proposed indirect disposal rules will have a noticeable impact. While there may be no change to the tax regime of funds that are not currently subject to tax due to specific tax codes, the disposal of the interests in such funds by non-UK residents will be subject to UK capital gains tax if the interests pass the ownership test (unless the investor is exempt from capital gains other than through non-residence). Osborne Clarke highlights that, based on the proposals, pension fund investors will be protected from tax arising from indirect disposals, but a pension fund may still suffer tax inefficiencies in relation to its commercial returns if the entity itself is taxable.
If we look at the significant implications of the proposed reform, is this a gamble that the UK real estate market can afford in the wider context of Brexit? Some commentators have highlighted that in London as much as 75% of property investments come from foreign sources and the new regime may cause the international real estate investment community to think twice. The British Property Federation has warned that “the Chancellor’s announcement on Capital Gains Tax for non resident investors is particularly unwelcome and we are planning an urgent and vigorous response,” while other commentators note that many landmark projects such as the Shard and Walkie Talkie buildings have been funded primarily by overseas investors, and that the reform could undermine the attractiveness of the UK as a jurisdiction.
The UK Government is expected to announce the full details of the reform by the summertime to come into force by April 2019. International investors and fund managers should watch this space carefully.
Client Director in Luxembourg