In March 2012, the UK Government announced its intention to make changes to the way in which property held by “non natural persons” was taxed.
In short, the Government was concerned that it was not receiving sufficient taxation from sales of UK domestic property and, it would appear, saw the UK and in particular the London domestic property market as a good source of revenue. Hence, it announced that it was considering the following changes:
At present, the changes listed in the last two bullet points above are contained in draft legislation and are subject to further consultation.
These changes will have a significant effect on residential property structures involving trusts and property-owning companies. Purchasers will now need to carefully evaluate the relative merits of any structure before buying a property and many directors, trustees and beneficiaries of existing structures will be looking for a solution or suitable method to unwind the schemes already in place.
The first step which taxpayers will need to consider is whether they are affected by the new rules. For new purchasers concerned about the enhanced level of SDLT they will need to identify whether they are looking to purchase a new property worth £2 million. For existing owners, the key aspect which the taxpayer will need to look at is the identification of how the property for which they are the beneficial owner of is actually held. For example, do they own the property outright, or is it contained within a UK or offshore company, trust or foundation structure?
In relation to the SDLT annual charge, taxpayers should then consider whether (a) the property they currently own is likely to be valued at £2 million and (b) whether they are likely to acquire any additional land or outbuildings which could potentially increase the value to this level.
In relation to the enhanced capital gains regime, the taxpayer will need to consider whether any capital gains have already accrued from the date of acquisition of the property and the significance of these. It may be that trustees of a property held in an offshore trust may have already minimised the level of capital gains which have accrued since the acquisition of the property, by having elected to revalue the base cost of the property for the purposes of capital gains tax as at 5 April 2008. If so, this would have occurred following the introduction of the amended rules for capital gains tax contained within the Finance Act 2008.
Once a taxpayer has identified that they are subject to the new rules, they should be made aware of the fact that the process of unwinding existing structures can expose the parties to tax charges which may prove more disadvantageous than those detailed above. Therefore it is crucial that taxpayers take into account the tax costs of entering into a new structure or changing an existing structure as well as the ongoing tax treatment of that structure.
In viewing the impact of these taxes, it will be important to consider the factors detailed in the points below in order to ascertain the best structure going forward, although it should be remembered that structuring property ownership is just one part, albeit a very important part, of a person’s tax and wealth planning. As such, any plan relating to property ownership should form an integral part of that person’s overall tax planning and should not be undertaken in isolation from it.
Use of the property
Any structure will depend on the purpose for which the property is to be used, for example, whether it is to be occupied by the beneficial owner of the structure as a residential home, or if the property is to be let or developed and sold on.
If the property is to be occupied as a residential home, then there may be the opportunity for the individual to make a claim for private residence relief against any capital gains tax liability.
If the property is to be let, a taxpayer will need to consider whether it would beneficial to own the property and receive rents, bearing in mind their applicable income tax rates, or whether it would be more appropriate for a company to receive the rent and pay UK tax at basic rate.
Where the property is to be developed as part of a development trade, the taxation of development profits should be taken into account in determining the correct tax structure. It is important to note that there is also an exemption from the effects of the annual SDLT charge for “bona fide property development businesses” which have been operating for over two years.
Residence of the structure
It is important to consider the residence status of the structure and whether this can be changed, as this will have an effect on how the new rules will take effect. This is particularly important when considering the application of the extension of capital gains tax to non natural persons resident outside of the UK.
The UK Government has not yet announced the rate at which the capital gains tax will apply to these non natural persons, however it may be that the cost of the tax proves higher for these offshore structures than UK based structures.
On the other hand, a non resident structure may be capable of benefiting from or being adapted to benefit from double tax treaty relief which may take it outside the scope of capital gains tax.
Residence and domicile of the beneficial owner
If a structure is to be unwound or the property purchased directly by an individual so that the individual may become personally exposed to UK tax, it is important to consider the beneficial owner’s residence and domicile. This is especially important if the property is likely to fall within the beneficial owner’s estate on his or her death for UK inheritance tax. UK inheritance tax is charged at a rate of 40% on assets worth over the current tax free allowance of £325,000.
Clearly, it would be advantageous for the value of property to fall outside of the beneficial owner’s estate for inheritance tax purposes. A person’s estate for a non domiciled individual includes UK assets (such as UK real estate) but does not include overseas assets such as shares in a non UK company owning UK real estate. Hence, depending on the age and anticipated residence profile of an individual, it may still be beneficial to keep or place the property in a non UK company with a view to avoiding inheritance tax. Further, non corporate vehicles, which may not attract the higher rate of SDLT or the annual charges, may be available to hold the property in a way such that the value of the property falls outside the scope of inheritance tax.
If the property does fall within the estate, then it may be a good idea to consider whether the beneficial owner is able to put in place a debt which can be charged against the property, for example a mortgage. The effect of a mortgage is that HMRC treats this type of debt as a liability which can be offset against the value of the property, provided that the debt is still outstanding at the date of death of the beneficial owner. This type of planning may be combined with remittance basis income tax planning. In addition to debt, life assurance policies can also provide relief from the effects of inheritance tax.
An alternative way of reducing the beneficial owner’s exposure to inheritance tax would be for the property to be held in a discretionary trust. The beneficiaries of the trust could be given a licence to occupy the property without the property falling into their estate on death. Discretionary trusts are subject to the “relevant property regime” and the associated charges which arise when assets are transferred into the trust, out of the trusts and on each tenth anniversary of the trust. However, there are currently opportunities to manage this type of charge.
Capital gains tax
Capital gains tax may not be payable on a property owned directly by a non UK resident individual. Where the owner is a UK resident, principal private residence relief may be available. Further, capital gains tax may be avoided by an individual waiting until he has ceased to be UK resident before selling the property.
Under the new rules, property held in an offshore company may be subject to capital gains tax as well as property in a UK resident company, as is currently the case.
If an individual either owns the land directly or is treated for tax purposes as if he owns the land directly, he will be liable for income tax on any income arising from the property whether he is UK resident or not. Income tax will be payable at his top rate of UK taxation and so may be charged at a rate of up to 50%. (A non UK resident company would only be liable to pay UK income tax at 20%). Hence, a taxpayer should consider whether it is more favourable to own a property directly and pay potentially higher rates of income tax or to own it via a company and pay income tax at a lower rate but potentially incur higher rates of SDLT, the annual charge and capital gains tax on a disposal of the property.
Additionally, thought should be given as to whether it is possible to place the property within a structure which enables the enhanced SDLT charge and annual charges to be avoided but the income to be treated as arising to a non resident company and so taxable at basic rate income tax.
A taxpayer will also need to consider whether the payment of the annual charge by the non natural person owning the property would constitute a remittance made in the UK on his behalf. If this is the case, the tax consequences of the annual charge may be much greater than originally anticipated.
Privacy and connections with other jurisdictions
One advantage of offshore structures is that they can provide a layer of privacy which can be used to shield an ultimate beneficial owner from being connected with either the property or the registered legal owner.
Also, there are cases where it is important to use an offshore company for reasons connected with another jurisdiction with which the individual or family is connected. These are both important factors which should not be forgotten when considering whether to change an existing structure.
It may also be relevant to consider whether any tax is being paid on the income and gains in any other jurisdiction. If so, it may be possible to seek immunity from the new rules on the basis of a double tax treaty which the UK may have with that particular jurisdiction.
In order to counter the effects of any capital gains tax, the idea of “rebasing” property values has been put forward during the consultation process, although at present the Government does not appear to have made any decision in relation to this at the time of writing.
If such an opportunity is provided, essentially, the base cost of the property (which would be used as a base on which to calculate any gain arising from a sale of the property) would be revalued at current market value, thereby eliminating any charge to capital gains tax arising now if the property is taken out of the structure now or reducing any future gain.
Depending on the individual factors and considerations involved in each existing property structure, there are various options available for the ways in which the property in question could be held going forward. A few of the more common structures which may be applicable include those listed below.
Creating a bare trust with nominees holding the property on behalf of the beneficial owner
Bare trusts are effectively ignored for all tax purposes and are generally seen as a tax transparent structure. Hence, if an individual is the beneficial owner of the property, he is not subject to the new SDLT rules for non natural persons. The property may fall within the owner’s estate for inheritance tax purposes. Hence, the owner should consider planning to reduce the effect of a potential inheritance tax charge as outlined above.
Further, any income or gains from the property will be taxable in the owner’s hands.
Creating a discretionary trust
Under the current draft legislation, a corporate or non natural entity acting in its capacity as a trustee falls outside of the new SDLT rules for non natural persons, hence the use of a discretionary trust may be a structure to consider. This effectively means that the property is unlikely to fall within the beneficial owner’s estate for inheritance tax purposes, although it will be subject to the relevant property regime (as detailed above). Without further planning, inheritance tax, income tax and capital gains tax would still be in point, although the use of a discretionary trust may make succession easier.
Transferring the property into a limited liability partnership (LLP)
It may be possible to combine an offshore LLP with a discretionary trust to remove an asset from the scope of UK inheritance tax, although any income and gains would be treated as arising to the trust directly and so would need to be considered further.
Purchasing an offshore company
The principal advantage is that SDLT on the acquisition would be avoided. Also, the value of the property may fall outside the scope of inheritance tax and income tax on rental income would be paid at basic rate. However, there would be an exposure to the annual charge and capital gains tax may be payable on a sale of the company or property, depending on the structure within which the company is acquired.
Corporate beneficiary of a trust
In addition, it is possible that the annual charge and the higher rate of SDLT would not apply where a trust of which the principal beneficiary is a company acquires the property. Income tax on rents may, depending on the trust, be payable at the basic rate and the property may fall outside the scope of inheritance tax, although it may be subject to capital gains tax.
At present it may be possible to seek to avoid paying higher rate SDLT on the acquisition of property to be held as trading stock whilst realising the trading profit in an offshore company through appropriate contractual arrangements. Profits realised by an offshore company may fall outside the scope of UK taxation.
Importing the residence of an offshore company
The new capital gains rules may only apply to offshore companies; UK companies being subject to the existing capital gains tax rules. If an offshore company can be imported to the UK by the appointment of UK directors, then there is the potential to minimise the impact of taxation on gains whilst not affecting the inheritance tax treatment. As detailed above, although UK resident companies pay corporation tax on gains, reliefs may be available to reduce such a liability.
In addition to the above suggestions, it is important to note that it may be appropriate for a structure to be maintained without any amendments being made. Once all of the tax implications have been assessed, the beneficial owner may find that the protection against inheritance tax outweighs the negative effects of the new rules.
The process of winding up existing structures in order to release the residential property from the application of the new rules could lead to other tax disadvantages. We would strongly suggest that advice is sought in relation to any existing structure prior to any action taken to effect a change in the legal ownership. As is to be expected, any advice to be given in relation to unwinding structures will be dependent on the factual situation in hand and will need to be tailored in order to suit this.