Many non-domiciled individuals own UK residential property through an offshore company/trust structure as these types of structures have, until recently, afforded many tax benefits. However, the lack of transparency regarding the true beneficial owners has led the UK government to seek ways to discourage their use and to encourage UK property to be held personally.
One way the government sought to achieve this was to introduce legislation that significantly increased the tax burden of UK residential properties owned through offshore structures. For many taxpayers, the increased tax charges now mean that it is no longer viable to continue to hold UK property in this way, and taxpayers are now considering dismantling such structures.
This briefing summarises the recent tax changes and considers the tax implications of transferring UK residential property into personal ownership (de-enveloping).
Summary of Recent Changes
- The 2012 Budget introduced the 15% rate of stamp duty land tax (SDLT) on acquisitions by companies and certain other non-natural persons of single dwellings valued at more than £2m.
- The 2013 Budget introduced the Annual Tax on Enveloped Dwellings (ATED) which came into effect from 1 April 2013 for residential properties worth more than £2m.
- With effect from 6 April 2013, UK capital gains tax was extended to disposals of property within the ATED charge (ATED-CGT), although relief is available to certain property rental, trading and development businesses.
- The 2014 Budget extended the scope of ATED to properties worth £1m or more with effect from 1 April 2015, and to those worth £500,000 or more with effect from 1 April 2016. As a result of the reductions in the ATED threshold, many more properties are also brought within the ATED-CGT charge.
- ATED charges were increased by over 50% from 1 April 2015 compared to the previous year. For example, the annual charge for residential properties worth over £20m increased from £143,750 (for 2014/15) to £218,200 from 1 April 2015.
The increased SDLT charge in particular may have deterred investors from structuring new acquisitions of UK residential property through offshore structures. However, many non-domiciled individuals with existing structures decided to retain them, and suffer the ATED charge, as a cost of retaining the exemption from inheritance tax (IHT).
Proposed IHT changes
Then came the announcement in the July 2015 Budget that all UK residential property, however owned, will be subject to IHT from 6 April 2017. This announcement will be the final nail in the coffin for many UK residential property structures, particularly where the property does not qualify for any of the ATED reliefs. As a consequence, many taxpayers are now looking at ways of ‘de-enveloping’ and bringing properties into personal ownership.
De-enveloping is not a straightforward exercise. Many tax considerations come into play and the process of de-enveloping could potentially give rise to significant tax charges. Taxpayers will need to take professional advice as each case needs to be examined with reference to its specific facts.
We consider below the main tax implications of de-enveloping, where property is transferred as an in-specie dividend following liquidation of the company.
Stamp Duty Land Tax (SDLT)
Usually, SDLT is payable where consideration is given by the shareholders for the transfer of the property. HMRC guidance confirms that where a liquidator distributes a property in specie SDLT is not payable in the following two instances:
- The company has no debt other than issued share capital, or
- There is debt but this debt is owed solely to the shareholder and the company has no other liabilities other than issued share capital. HMRC do not regard the cancellation of the loan as constituting consideration.
However, if the shareholder assumes an existing third party debt when the company is liquidated, SDLT is payable on the amount of debt assumed.
There may also be a charge if third party debt is repaid before liquidation of the company where the shareholder provides funds to the company to allow it to discharge the debt, although this will depend on the facts of each case.
Capital Gains Tax (CGT)
On liquidation of the company, the company is deemed to dispose of the property for market value. There are three main tax issues to consider:
- ATED-CGT from 6 April 2013.
- Non-residents CGT (NRCGT) from 6 April 2015.
- Attribution of company gains to shareholders under s13 TCGA 1992.
ATED Capital Gains Tax (ATED-CGT)
With effect from 6 April 2013 capital gains tax was extended to certain non-natural persons when they dispose of UK residential property within the scope of the ATED regime. This ATED-CGT charge is levied at a flat rate of 28%, with no indexation allowance.
Where a property was purchased before 6 April 2013 but disposed of after that date, the ATED-CGT charge only applies to the part of the gain which accrued on or after 6 April 2013, or the date from which the property became liable to ATED, if later.
Where a property is not within ATED, for example because it is rented out to an unconnected third party, the gain will not be chargeable to ATED-CGT, although it may still be chargeable under one of the other provisions mentioned above.
Non-Residents CGT (NRCGT)
From 6 April 2015, non-residents (including companies, partners and trustees) are subject to UK capital gains tax on gains arising from the disposal of UK residential property.
Only the portion of the gain arising after 6 April 2015 is chargeable to tax. The rate of CGT is 20% for companies.
ATED-CGT takes priority over the NRCGT charge, so where the property does not qualify for one of the ATED exemptions, the portion of the gain arising after 6 April 2013 will be charged to ATED-CGT, not NRCGT.
In cases where a property owned by a non-resident company qualifies for an ATED relief, no ATED-CGT is payable, and only the gain arising from 6 April 2015 will be charged to NRCGT at a rate of 20%, after indexation relief.
Gains attributed to shareholders under s13 TCGA 1992
This provision allows gains of an overseas company to be apportioned to UK resident participators who own (together with any connected persons) more than a 25% share in the company. Attribution of the gain can also be made to non-resident trustees.
The gain is calculated under corporation tax rules and indexation allowance is available. Capital gains tax is charged on the participator at the standard rates (currently 10%/20%).
Note that a gain can only be taxed under this section to the extent that it is not chargeable to ATED-CGT or NRCGT. Therefore it is possible that where a property is transferred out of a company into personal ownership, two separate calculations may need to be performed:
- The portion of the gain calculated under ATED-CGT or NRCGT rules as the case may be.
- The earlier portion of the gain, calculated under normal corporation tax rules, and attributed up to participators under s13 TCGA 1992, and taxed in the hands of the participator at the standard CGT rates of 10%/20%.
The application of s13 is subject to an important motive defence which applies where it is shown that neither the disposal of the asset by the company, nor the acquisition or holding of the asset by the company, formed part of a scheme or arrangements of which the main purpose, or one of the main purposes, was the avoidance of UK CGT or corporation tax.
The taxpayer’s circumstances and reasons for setting up the structure will need to be closely examined to determine whether the motive defence can be invoked.
Shareholder gain on liquidation
The gain on the disposal of the shares is taxable on the shareholder at the standard CGT rates (10%/20%). In most cases, the chargeable gain will represent the increase in value of the property from acquisition.
The economic gain may also be taxable under one of the provisions set out above, and therefore there is the potential for a double tax charge. Consideration will need to be given as to whether any relief is available under the distribution relief provisions. If no relief is available, any ATED-CGT or NRCGT tax can be deducted from the shareholder gain.
UK property held in offshore company / trust structure
Where the offshore company is held by non-resident trustees, de-enveloping could potentially give rise to a double tax charge:
- On liquidation of the company, the company is deemed to dispose of the property for market value. The portion of the gain not chargeable under ATED-CGT or NRCGT is apportioned up to the trustees under s13 (subject to the motive defence) and added to the trustees’ pool of stockpiled gains. The gain is not chargeable on the trustees themselves, but can be matched to capital distributions made to a UK resident non-domiciled beneficiary under s87 TCGA 1992. Whilst the remittance basis is available, in the situation where the property is transferred out of the trust structure to a UK resident beneficiary, there would be an immediate taxable remittance as the property is UK situs.
- The trustees are deemed to have disposed of the shares for their market value immediately prior to liquidation. Assuming that the shares derive their value from the property, in most cases the share gain would represent the increase in value of the property.
In certain circumstances, there may be some form of relief available from the double charge, and each case will need to be considered on its own facts.
Given the possible tax charges associated with de-enveloping and the potential for a double tax charge in certain cases, it has been suggested that some form of de-enveloping relief should be available to defer the CGT charges until the property is eventually disposed of. Otherwise, the tax liabilities could be a significant barrier to de-enveloping, or in some cases may even be prohibitive.
If a relief is introduced, it remains to be seen what the position will be for taxpayers who have already de-enveloped, and for those who may have already paid associated tax charges.
Future Taxes once property is held personally
Inheritance Tax (IHT)
Once in personal ownership, the property will form part of the individual’s estate for inheritance tax purposes and will be chargeable to IHT at 40%.
Some relief may be available for chargeable estates worth less than £2m if the property becomes the individual’s main home and advantage can be taken of the new Residence Nil Rate Band which is being phased in from 6th April 2017 and will provide relief up to £175,000 (£350,000 for a married couple or civil partners) by 6th April 2020.
Capital Gains Tax (CGT)
Any future gain will be liable to CGT at a rate of 28%. CGT may be mitigated or avoided under the principal residence relief (PRR) rules if the property becomes the individual’s main home and the other conditions for PRR are met.
It should be noted that the PRR rules were changed from 6 April 2015. From 6 April 2015, a property will generally only qualify as a PRR for a year if the individual or their spouse is resident in that country for the year or the individual or their spouse spends at least 90 nights in that property (or another property in that country) during that year.
Given the potential tax charges involved with the winding up of existing structures, it is essential for those affected to take comprehensive professional advice as soon as possible.