Author: Neal Todd
Many occupiers pay their rent to offshore landlords.
For decades it has made good tax planning sense for landlords – and other owners of UK real estate – to be based offshore.
Holding a land interest from outside the UK has historically allowed appreciation in the value of property to escape UK tax.
And whilst rent received by offshore landlords has been liable to UK Income Tax, in practice that tax has been easy to shelter through the use of external leverage and shareholder debt (interest expense is usually deductible in computing taxable profits for landlords).
Over recent years, however, the tax landscape has changed in radical ways.
At first, the main changes were seen in the residential sector. Government policy from 2013 onwards made it increasingly expensive – some would say penal – to hold residential property in any form other than individual ownership.
This policy was implemented through a combination of measures: increased rates of transfer duty (SDLT); the so called “annual tax on enveloped dwellings”; and, most recently, the imposition of Capital Gains Tax on many offshore owners of UK residential land.
The focus is now moving to the commercial sector.
As from the summer of 2016 the territorial scope of UK Corporation Tax has been extended to bring the profits of non-UK resident companies dealing in, or developing, UK land within its ambit.
The Government has now launched a new consultation (inviting comments by 9 June 2017 – handily in time for the next administration to be formed after the General Election) on whether UK Corporation Tax should be broadened to apply to offshore corporate landlords who hold their UK property interests for investment purposes.
Making landlords subject to Corporation rather than Income Tax may sound like a technical detail of importance only to those who do computations.
Little could be further from the truth.
Whilst the headline rate of Corporation Tax is slightly lower than Income Tax (19% as opposed to 20% for the current year) the effect of bringing foreign company landlords into the UK Corporation Tax net will be to limit their deductions for interest and other finance expenses in the same way as regular onshore companies.
Particularly for larger landlords this is likely to lead to a significant increase in their UK tax burden. This is because, after the first £2 million of interest expense, relief for financing costs is limited on a formulaic basis (the general rule being that interest expense is allowed to the extent only that it does not exceed 30% of EBIDTA) under new rules restricting the tax deductibility of interest payments.
These rules already apply to UK Corporation Tax payers for periods beginning from 1 April 2017. So, to that extent, if the result of the consultation is that offshore corporate landlords are also brought within their scope, the playing field will be levelled.
But whether it is appropriate for these rules to be applied in their full rigour to the highly leveraged real estate sector is an entirely different matter. Other than for a limited exemption from the rules for public infrastructure projects, the real estate industry’s attempts to persuade the Government to lighten the impact of these rules on property owners has fallen on deaf ears.
Landlords of commercial property will often continue to be based offshore if only because (happily) there has been no suggestion that UK Capital Gains Tax should be extended to commercial property.
But assuming that the result of the consultation is that offshore company landlords become liable to the full rigour of the UK’s Corporation Tax regime, it seems very likely that they will end up paying more tax on their rental receipts – which, in due course, can be expected to feed through to increased rental demands for tenants.
Fladgate will be commenting on the consultation currently underway by making appropriate representations. Any reader who is interested in discussing the form of those representations is welcome to contact us by 30 May 2017.
Neal Todd, Partner, Fladgate LLP (firstname.lastname@example.org)