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Budget 2014 included the announcement of yet further tax changes in relation to UK residential property. Ostensibly focused on non-UK resident owners, the proposed changes may in fact have a major impact on UK residents with more than one home.
Under current UK tax rules, non-UK resident individuals are generally outside the scope of UK capital gains tax (CGT). As a result, a non-UK resident individual who owns UK residential property (either as a home or as a rental property) can sell that property at a gain, without paying any CGT.
However, in this respect the UK is out of step with most other countries, which tax gains on property sales by non-resident owners.
In December 2013, the Government announced that it was considering an extension of the scope of CGT to catch non-UK resident individual owners of UK residential property, to correct this anomaly. On 28 March 2014, the Treasury published a consultation paper setting out the detail of its proposals.
The consultation is open for comments until 20 June 2014. Any changes which the Government decides to make will take effect on 6 April 2015 rather than immediately, so there is time for non-residents to take advice on their position and, if desirable, to take action to mitigate their CGT position.
As explained below, the consultation document does not give the impression of a very well-developed policy in relation to the taxation of residential properties.
What is evident is that the Government has realised that, over the last decades, it has been losing out on a substantial amount of tax which could have been collected from non-UK residents; wealthy foreign home-owners and foreign investors in the UK residential property market represent a cash cow that has, until recently, not been milked.
The Government is now taking urgent steps to remedy this.
When these further changes to the taxation of UK residential property were first announced in December 2013, there was speculation about the following:
The consultation paper has addressed the first three of these points.
The consultation paper is silent on whether there will be an automatic rebasing for non-UK residents now brought into the CGT regime.
However, as the consultation paper refers to the new regime applying to gains "arising from" 6 April 2015, it seems likely (based on previous experience) that there will be rebasing.
The consultation document provides little detail on the proposal to extend CGT to trustees of non-resident trusts. This idea was previously mooted at the time the ATED and ATED-related gains changes were first proposed.
In Finance Act 2013, trusts were expressly carved out of the ATED and ATED-related gains provisions. Perhaps inevitably, the Government is now looking at this issue again.
It is unclear how a charge on trustees would interact with the existing CGT regime for offshore trusts, but it is assumed that this would operate in a similar way to properties held by ATED-affected companies in offshore trusts, where any gain subject to immediate charge under these new rules would then not fall into the trust gains pool for matching against benefits conferred on beneficiaries.
From a policy perspective, the current Government is keen to bring non-UK residents into the UK tax system on disposals of all kinds of UK residential property, whether the property is occupied by the owner or let to third parties on commercial terms.
Development properties are already within the scope of UK income tax in the case of individuals (and corporation tax in the case of companies), as land development constitutes a UK trade. Rental properties, however, are not currently caught by this regime.
When the ATED-related gains regime was introduced by Finance Act 2013 for companies owning UK residential properties, an express relief was introduced from ATED and CGT on ATED-related gains if the property was let commercially to an unconnected third party.
The Government seem to have had second thoughts about this, but is now at pains to avoid giving the impression that there has been a U-turn. In the consultation document, the Government is said to be minded to introduce a "tailored approach within CGT or corporation tax to charge gains made on disposals of UK residential property by non-resident companies", which will operate alongside the ATED-related gains regime.
It is most unclear what the Government intends by this. It is difficult to avoid the suspicion that the Government does not, itself, know how to rationalise this area of tax law, which is becoming intricate and risks becoming incoherent.
In our (tentative) view, the most likely outcome is that non-resident companies owning commercially let properties will become subject to corporation tax (to be levied at a rate of 20% from 6 April 2015), thereby aligning the treatment with development properties owned by non-resident companies.
This will also enable the Government to retain the distinction between (on the one hand) commercially-let residential properties and (on the other) homes owned by non-resident companies which are not let commercially, which are instead caught by the CGT charge for ATED-related gains (currently levied at 28%).
The other issue raised in the consultation paper, which is potentially of much wider significance, concerns the availability of PPR.
Under current law, PPR provides relief from CGT where an individual sells a property which throughout the individual's period of ownership has been their only home, so that any gain realised on the sale is CGT free. There is no limit on the amount of gain that can be exempted from CGT by PPR.
If the property has not been used as the individual's only home throughout the period of ownership, eg if it has been rented out for part, this may reduce the availability of PPR, so that only a proportion of the gain is CGT free.
PPR can also apply where an individual has multiple homes.
In such circumstances, under current law, either PPR will apply to the home which, factually, is the individual's main home (basically, the home which is most regularly used as such), or the individual can submit an election to HMRC to elect which of their homes they wish to benefit from PPR (so not necessarily their factual main home).
Such an election must be made within 2 years of any change in the number of residences used by the individual personally - so within 2 years after the last acquisition or disposal of a residence.
These elections can sometimes be used to move the benefit of PPR around a portfolio of homes - a process colloquially known as 'flipping'.
If CGT is extended to all non-UK resident owners of UK residential property, the current PPR rules would undoubtedly reduce the impact of this tax change, as an individual could elect for PPR to apply to a residence, even if that residence was not, factually, their main home.
An individual resident in (for example) Dubai who owns an expensive London townhouse could make an election that the London house should be treated as his main home for PPR purposes, notwithstanding that he might only use the property for a few days a year.
Provided that the property is, factually, a home of his (ie not let out), the election would be valid under current rules. It would prevent any CGT being payable on the gain eventually realised when the property is sold.
There would be no CGT exposure in the UK (nor any in Dubai).
In the light of this, the Government is considering removing the ability to make elections under the PPR regime and to replace this with either a factual test or a time spent test.
As a result, a non-UK resident property-owner would rarely, if ever, be entitled to the relief.
It appears that the proposed removal of PPR elections will apply across the board and not just to non-UK residents. The reason for this may be that tax rules now need to comply with principles in the EU treaty preventing discrimination against residents of other EU countries.
A system which prevented elections by non-UK residents would discriminate against those non-UK residents who are resident in other countries of the EU.
However, this area of tax law has also arguably been ripe for reform for some time. PPR 'flipping' is often depicted in press coverage (incorrectly) as tax avoidance.
If this change is made, it will have a widespread impact for UK residents.
It is relatively common for individuals in the UK to have a couple of homes (eg a country house and a London flat), and also quite common to take advantage of the current ability to elect that one of those properties should be treated as the main home, to avoid CGT on that property, in circumstances where as a matter of fact it would not be the main residence.
PPR elections can be in point not only where one individual owns multiple homes, but also where a married couple (or civil partners) between them own more than one home. Under current rules, a married couple (or civil partners) is only permitted one main residence for CGT purposes between them.
In these situations, the PPR election rules can be very important in reducing the impact of CGT when one of these homes is sold.
It is not yet known whether any grandfathering will be available for PPR elections made before 6 April 2015.
However, as this must be a possibility, both resident and non-resident individuals alike who are still within the 2 year window for making a PPR election should consider doing so now.
Non-UK resident individuals planning to dispose of a property over the next 12 months should consider expediting the sale so that it is completed (or at least exchanged) before 6 April 2015, when these changes are due to become law.
Non-UK resident individuals who hold UK residential property standing at a substantial gain, and who are outside the 2 year window for making an election, should consider whether they wish to take steps to rebase the value of their property for CGT purposes before 6 April 2015, or whether they are content to rely on the possibility of automatic rebasing being introduced by the Government.
Any individual or non-UK resident trustee potentially affected by the changes should seek advice in good time before the changes are brought into effect.
This article was written by Dominic Lawrance.
For more information please contact Dominic on +44 (0)20 7427 6749 or firstname.lastname@example.org