UK real estate, particularly prime property in London, has always attracted significant international investment. Now, as the UK property emerges from recession, there are renewed opportunities to benefit from significant capital growth and healthy rental streams.
Investment in UK real estate must be structured carefully to mitigate UK tax at source on income, gains and transactions. Taxes may be levied on rents, development profits and capital gains, and there also stamp taxes (see below) and inheritance taxes to consider.
I look at a number of common investment scenarios below, and particular structures which will help to shelter the investments from UK tax.
I look at a number of common investment scenarios below, and particular structures which will help to shelter the investments from UK tax.
Individual purchase of one or more UK properties
Many purchasers simply look to buy a single UK property to use as a base.
Others wish to develop a portfolio of properties under single ultimate ownership. Many of these properties will be rented on the open market.
Others wish to develop a portfolio of properties under single ultimate ownership. Many of these properties will be rented on the open market.
It should be mentioned at the outset that a non-resident is not subject to UK tax on capital gains, even where derived from UK assets. This includes a non-resident individual, partnership or company. Investment properties can therefore be sold on at a gain in the future without tax considerations (although note below that there may be different treatment where a property is acquired, developed and sold on in a relatively short period of time).
A private use property will not be subject to any taxes on (deemed) income in the UK whilst the owners remain non-resident for UK tax purposes. On the other hand, profits deriving from UK rental receipts are taxable in the UK in all cases, on the following basis:
- Non-resident individual owner: at a rate of between 20% and 50% on income depending on the level of profits
- UK resident company: 26% on income and gains
- Non-resident company: 20% on income only.
Clearly, it is preferable for the investment(s) to be made through a non-resident company, preferably in a low tax jurisdiction.
An overseas landlord is required to register with HMRC under the Non-Resident Landlord Scheme. Strictly, 20% tax must be withheld by the tenant or agent from net rents. However, approval can be obtained from HMRC for rents to paid gross, providing an annual tax return is filed and tax paid on time.
To reduce net rents chargeable to UK tax, it is often advisable for the shareholder to loan the company funds to purchase the property. Interest is then paid as an allowable deduction from rents. The loan should be secured on the property in order to obtain a maximum deduction on arm's length principles under the UK transfer pricing legislation. There must also be a commercial level of equity contribution and a suitable interest rate.
To reduce net rents chargeable to UK tax, it is often advisable for the shareholder to loan the company funds to purchase the property. Interest is then paid as an allowable deduction from rents. The loan should be secured on the property in order to obtain a maximum deduction on arm's length principles under the UK transfer pricing legislation. There must also be a commercial level of equity contribution and a suitable interest rate.
Planning should be undertaken to ensure the interest paid has a non-UK source, to avoid UK withholding tax.
In many cases the shareholder advancing the loan will be a second BVI company which will not be chargeable to tax on its interest receipts.
A further advantage in using a non-UK company is that it eliminates exposure to UK inheritance tax (IHT).
UK IHT is levied on all UK-situate assets on the death of the owner, regardless of residence or domicile status.
The tax is levied at a rate of 40% above a threshold value of £325,00 .
By using a non-UK company (note the company must be incorporated outside the UK and its shares or register kept outside the UK, not merely a non-UK resident one) the assets comprised in the estate on death are then shares in the foreign company rather than the UK real estate. Such shares are exempt from IHT for a non-UK domiciliary.
UK IHT is levied on all UK-situate assets on the death of the owner, regardless of residence or domicile status.
The tax is levied at a rate of 40% above a threshold value of £325,00 .
By using a non-UK company (note the company must be incorporated outside the UK and its shares or register kept outside the UK, not merely a non-UK resident one) the assets comprised in the estate on death are then shares in the foreign company rather than the UK real estate. Such shares are exempt from IHT for a non-UK domiciliary.
Classic UK property ownership structure:
Collective Investment Schemes for UK Real Estate
Although there are many individual private investors in London real estate, a collective investment scheme or fund is often required to generate sufficient purchasing power and / or leverage.
As such they have become popular over the last ten years at both the public and private level.
As such they have become popular over the last ten years at both the public and private level.
Authorised Funds with Diversity of Ownership
REIT
At the public level, the UK introduced the Real Estate Investment Trust (REIT) in 2006.
The REIT is a listed fund undertaking a property rental business. It is suitable for both personal and institutional investors.
The advantage of a REIT is that income and gains are not taxed at REIT level, although withholding taxes often apply on distributions to investors and there is an annual requirement to distribute up to 90% of property income profits.
Due to the listing requirement a REIT is not suitable for structuring a private property fund.
PAIF
The REIT is a listed fund undertaking a property rental business. It is suitable for both personal and institutional investors.
The advantage of a REIT is that income and gains are not taxed at REIT level, although withholding taxes often apply on distributions to investors and there is an annual requirement to distribute up to 90% of property income profits.
Due to the listing requirement a REIT is not suitable for structuring a private property fund.
PAIF
As an alternative to the REIT, the Property Authorised Investment Fund (PAIF) was introduced to allow a tax-favoured property fund to be formed without a listing requirement.
The tax benefits are broadly similar to the REIT, but again withholding taxes will often be levied on distributions from the fund.
Despite the reduced scale of the PAIF, there is still a rigorous "diversity of ownership" requirement, meaning that smaller groups of investors will still not be able to benefit.
The tax benefits are broadly similar to the REIT, but again withholding taxes will often be levied on distributions from the fund.
Despite the reduced scale of the PAIF, there is still a rigorous "diversity of ownership" requirement, meaning that smaller groups of investors will still not be able to benefit.
Authorised UK real estate fund:
Private Property Fund Vehicles
As a result of these restrictions some have been active in developing non-UK based fund structures able to provide similar, or more extensive, tax advantages without the ownership restrictions placed on UK-based schemes.
ICIS
ICIS
In particular, the Cyprus Private Fund or ICIS is ideally suited as a private collective investment scheme for UK property. It combines the benefits of an EU-regulated fund which, when effectively structured, can achieve very low UK and overseas tax leakage.
Cyprus funds are a good on-shore alternative to the traditional unit trusts established in Jersey, Guernsey or the Isle of Man, or may be combined with a traditional tax-efficient offshore investment structure.
Cyprus funds are a good on-shore alternative to the traditional unit trusts established in Jersey, Guernsey or the Isle of Man, or may be combined with a traditional tax-efficient offshore investment structure.
Carefully structured financing, in accordance with UK transfer pricing principles, can reduce the UK tax charge significantly, whilst the profits received in Cyprus as dividends are not subject to local taxes.
Dividends and / or interest can then be paid out to the ultimate investors free of Cypriot withholding tax.
Dividends and / or interest can then be paid out to the ultimate investors free of Cypriot withholding tax.
Cyprus Private Fund for UK Rentals:
Simple Co-Ownership Structures
A group of investors looking to invest in a particular project may consider forming a UK Limited Partnership, typically where they are not looking to attract further funds in the future from other investors.
Each partner contributes funds to the partnership and takes an interest in the underlying partnership assets and income as a limited partner. As a limited partner, liability is limited to the sum invested and undrawn profits.
Each partner contributes funds to the partnership and takes an interest in the underlying partnership assets and income as a limited partner. As a limited partner, liability is limited to the sum invested and undrawn profits.
The partnership is transparent for UK tax purposes so that only income (not gains) arising in the UK will be taxable on the members.
An unlimited partner, often an offshore company, is appointed to manage the assets but has no interest in underlying income or capital.
An unlimited partner, often an offshore company, is appointed to manage the assets but has no interest in underlying income or capital.
The advantage of a limited partnership structure is its flexibility, in that relations between partners are governed by a partnership agreement which can be altered at any time by agreement.
The disadvantage is that the structure is relatively illiquid, unlike a fund where units or shares may be traded more easily.
Care must be taken in structuring borrowings to reduce the UK tax charge, as there are restrictions applicable to partnership structures.
The disadvantage is that the structure is relatively illiquid, unlike a fund where units or shares may be traded more easily.
Care must be taken in structuring borrowings to reduce the UK tax charge, as there are restrictions applicable to partnership structures.
Limited Partnership Structure:
Planning for UK Property Developments
The UK property development market is picking up again and has been a popular investment choice for non-residents over the last 10 years.
Typically a site isacquired, developed and then sold on at a profit in a relatively short period of time. Such an activity is considered a trading activity in the UK, subject to income taxes on trading profits. As such the amount of tax at stake is often considerable and careful planning is required.
Short Term Development (Under 12 months)
Short Term Development (Under 12 months)
Short-term developments may avoid UK tax altogether when the developer is a company based in a jurisdiction with which the UK has a suitable tax treaty.
The treaty should state that a building site does not constitute a permanent establishment (PE) until the expiry of 12 months.
This has typically involved the use of companies in Jersey, Guernsey or the Isle of Man.
Long Term Development (Over 12 months)
The treaty should state that a building site does not constitute a permanent establishment (PE) until the expiry of 12 months.
This has typically involved the use of companies in Jersey, Guernsey or the Isle of Man.
Long Term Development (Over 12 months)
Most developments last longer than 12 months and therefore a PE in the UK is unavoidable.
In such cases, planning can be undertaken to ensure that only profits directly attributable to the PE come into charge to UK tax.
With careful planning, significant pre-development profits, such as increases in value on securing planning permission, can be kept out of the UK tax net.
In such cases, planning can be undertaken to ensure that only profits directly attributable to the PE come into charge to UK tax.
With careful planning, significant pre-development profits, such as increases in value on securing planning permission, can be kept out of the UK tax net.
Such an offshore development vehicle is particularly attractive when combined with a Cyprus private fund, allowing a bespoke group of investors to collectively finance a development.
There will be no further tax on the dividends received in Cyprus from the Jersey company, as they derive from a trading activity
There will be no further tax on the dividends received in Cyprus from the Jersey company, as they derive from a trading activity
UK Property Development Structure:
Summary
UK real estate continues to represent an excellent investment opportunity for nonresidents. Structured carefully, the UK and international tax leakage can be minimised. There are also opportunities for collective investment in UK property within tax-efficient structures.
Note on Stamp Duty Land Tax
(This note is not exhaustive and appropriate professional advice should be taken before entering into transactions.)
Note on Stamp Duty Land Tax
(This note is not exhaustive and appropriate professional advice should be taken before entering into transactions.)
Stamp Duty Land Tax rates and thresholds
Stamp Duty Land Tax (SDLT) is charged on land and and property transactions in the UK.
The tax is charged at different rates and has different thresholds for different types of property and different values of transaction.
The tax rate and payment threshold can vary according to whether the property is in residential or non-residential use, and whether it is a freehold or leasehold.
SDLT relief is available for certain kinds of property or transaction.
SDLT rates for residential property
The table below applies for all freehold residential purchases and transfers and the premium paid for a new lease or the assignment of an existing lease. (If the property will be used for both residential and non-residential purposes the rates differ - please see the section 'SDLT for non-residential or mixed use property').
New leases
If the transaction involves the purchase of a new lease with a substantial rent there may be an additional SDLT charge to that shown below, based on the rent.
Residential land or property SDLT rates and thresholds
Purchase price/lease premium or transfer value SDLT rate
Up to £125,000 Zero
Over £125,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 to £1 million 4%
Over £1 million to £2 million 5%
Over £2 million from 22 March 2012 7%
Over £2 million from 21 March 2012
(purchased by certain persons
including corporate bodies) 15%
If the value is above the payment threshold, SDLT is charged at the appropriate rate on the whole of the amount paid.
For example, a house bought for £130,000 is charged at 1 per cent, so £1,300 must be paid in SDLT.
A house bought for £350,000 is charged at 3 per cent, so SDLT of £10,500 is payable.
£2 million threshold for wholly residential property
From 22 March 2012 SDLT on residential properties over £2 million is charged at 7 per cent
It does not apply to non-residential or mixed-use properties.
If you exchanged contracts before the higher rate came into force on 22 March 2012) the 5 per cent rate will apply.
This only applies where the contract is unconditional and unaltered on or after 21 March 2012.
Higher rate for corporate bodies
From 21 March 2012 SDLT is charged at 15 per cent on interests in residential dwellings costing more than £2 million purchased by certain non-natural persons.
This broadly includes bodies corporate, for example companies, collective investment schemes and all partnerships with one or more members who are either a body corporate or a collective investment scheme.
There are exclusions for companies acting in their capacity as trustees for a settlement and property developers who meet certain conditions.
If you exchanged contracts before the higher rate charge came into force on 21 March 2012, the 5 per cent rate will apply. This only applies where the contract is unconditional and unaltered on or after 21 March 2012.
SDLT rates for non-residential or mixed use properties
Non-residential property includes:
A mixed use property is one that incorporates both residential and non-residential elements.
The table below applies for freehold and leasehold non-residential and mixed use purchases and transfers
If the transaction involves the purchase of a new lease with a substantial annual rent, there may be additional SDLT charge to that shown below, based on the rent.
Non-residential land or property rates and thresholds
Purchase price/lease premium or transfer value (non-residential or mixed use) SDLT rate
Up to £150,000
- annual rent is under £1,000 Zero
Up to £150,000
- annual rent is £1,000 or more 1%
Over £150,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 4%
Note that for the above purpose the annual rent is the highest annual rent known to be payable in any year of the lease.
Stamp Duty Land Tax (SDLT) is charged on land and and property transactions in the UK.
The tax is charged at different rates and has different thresholds for different types of property and different values of transaction.
The tax rate and payment threshold can vary according to whether the property is in residential or non-residential use, and whether it is a freehold or leasehold.
SDLT relief is available for certain kinds of property or transaction.
SDLT rates for residential property
The table below applies for all freehold residential purchases and transfers and the premium paid for a new lease or the assignment of an existing lease. (If the property will be used for both residential and non-residential purposes the rates differ - please see the section 'SDLT for non-residential or mixed use property').
New leases
If the transaction involves the purchase of a new lease with a substantial rent there may be an additional SDLT charge to that shown below, based on the rent.
Residential land or property SDLT rates and thresholds
Purchase price/lease premium or transfer value SDLT rate
Up to £125,000 Zero
Over £125,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 to £1 million 4%
Over £1 million to £2 million 5%
Over £2 million from 22 March 2012 7%
Over £2 million from 21 March 2012
(purchased by certain persons
including corporate bodies) 15%
If the value is above the payment threshold, SDLT is charged at the appropriate rate on the whole of the amount paid.
For example, a house bought for £130,000 is charged at 1 per cent, so £1,300 must be paid in SDLT.
A house bought for £350,000 is charged at 3 per cent, so SDLT of £10,500 is payable.
£2 million threshold for wholly residential property
From 22 March 2012 SDLT on residential properties over £2 million is charged at 7 per cent
It does not apply to non-residential or mixed-use properties.
If you exchanged contracts before the higher rate came into force on 22 March 2012) the 5 per cent rate will apply.
This only applies where the contract is unconditional and unaltered on or after 21 March 2012.
Higher rate for corporate bodies
From 21 March 2012 SDLT is charged at 15 per cent on interests in residential dwellings costing more than £2 million purchased by certain non-natural persons.
This broadly includes bodies corporate, for example companies, collective investment schemes and all partnerships with one or more members who are either a body corporate or a collective investment scheme.
There are exclusions for companies acting in their capacity as trustees for a settlement and property developers who meet certain conditions.
If you exchanged contracts before the higher rate charge came into force on 21 March 2012, the 5 per cent rate will apply. This only applies where the contract is unconditional and unaltered on or after 21 March 2012.
SDLT rates for non-residential or mixed use properties
Non-residential property includes:
- commercial property such as shops or offices
- agricultural land
- forests
- any other land or property which is not used as a dwelling
- six or more residential properties bought in a single transaction
A mixed use property is one that incorporates both residential and non-residential elements.
The table below applies for freehold and leasehold non-residential and mixed use purchases and transfers
If the transaction involves the purchase of a new lease with a substantial annual rent, there may be additional SDLT charge to that shown below, based on the rent.
Non-residential land or property rates and thresholds
Purchase price/lease premium or transfer value (non-residential or mixed use) SDLT rate
Up to £150,000
- annual rent is under £1,000 Zero
Up to £150,000
- annual rent is £1,000 or more 1%
Over £150,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 4%
Note that for the above purpose the annual rent is the highest annual rent known to be payable in any year of the lease.
