Radical changes to the taxation of UK real estate were announced in the autumn Budget.
Investment into UK real estate has long had a privileged status, especially for investors based overseas. But over the last few years those tax privileges have been whittled away.
Two years ago the UK extended Capital Gains Tax to individuals and closely held companies owning UK residential property. Last year the UK tax code was amended to make sure that profits from development of UK land were taxed wherever they arose. And in this year’s Budget the Government has announced that with effect from April 2019 offshore investors will pay Capital Gains Tax on their profits from UK commercial real estate.
Whilst this announcement takes the form of a consultation, it is clear that none of the main features of the new rules are up for grabs. The consultation is to be on some of the finer details of the tax and not on the fact that there will be a charge or the timing of its introduction (both of which are said to be “fixed”).
So exactly what is the Government proposing?
The main change is that non-UK resident sellers of commercial property will pay Capital Gains Tax on profits arising after April 2019. Existing structures will be caught as much as new investments, with existing holdings being rebased to market value as at that date.
Importantly, the change will also extend to persons selling interests in “property rich” offshore vehicles (meaning companies and other entities that derive 75% or more of their value from UK real estate). And, in a further change to the taxation of residential property, sales by widely held companies will now fall into charge.
What will be the main effects of the changes?
The main consequence of these changes will be to drive investment into UK real estate onshore.
In the future it will normally be better to hold UK property through onshore companies (or other vehicles) than from offshore. Whilst UK Corporation Tax rates are relatively low (scheduled to be 17% by the end of the decade) investors will be worried that a future government may take the opportunity to increase rates.
The name of the game from the tax planning perspective will be to drive as many tax deductible items into the onshore vehicle as possible, although – in something of a “double whammy” to this highly leveraged sector – property investors will be disappointed to find that the UK has also recently tightened up the rules on tax deductible interest and other financing costs.
Who will be the winners and losers?
The main winners from the change will be the UK based property companies and funds, especially REITs. Until now UK investors have been at a significant disadvantage to their offshore counterparts – but the pendulum will now swing firmly in the opposite direction.
REITs (onshore real estate investment trusts with tax privileged status) – which have been something of a slow burn since they were first introduced in this country a decade or so ago – may now become as popular in the UK as they have long been in the US and other markets.
The losers are, of course, the myriad Far Eastern and other offshore investors who have long invested in the UK commercial (and, until recently, residential) property market precisely because this country offered tax breaks which were not found elsewhere in Europe or, indeed, in most other jurisdictions.
Whilst the Government can correctly say that these changes do no more than bring the UK rules into alignment with those operating in most other markets, they are being introduced at a sensitive moment for the UK.
The Government must be hoping that the UK property market is robust enough to survive their imposition, and/or that those investors who would have put their money into bricks and mortar can be persuaded to invest in the UK’s fintech and other sectors that are being so actively promoted in the international community at the current time.
It will be some years before we can judge whether that hope turns out to be well placed but, if it is not, this consultation may come to be seen as the moment at which the UK turned its back on the large swathes of international capital that have for so long supported the UK commercial property market.