Investing in Hotels – UK tax considerations: A Guide for Family Offices

This article follows on from “Investing in Hotels: A Guide for Family Offices” and provides an overview of some key UK tax considerations when investing in a UK hotel business (as well as some points to be aware of when operating and exiting from the business).

One important point should be noted from the outset. UK tax rules applying to non-UK residents investing in UK real estate, including hotel assets, have changed significantly in recent years. Whilst UK hotel trading income has always been subject to UK tax regardless of whether the business is held in a non-UK jurisdiction, it is now also the case that capital growth on the underlying property asset can also now subject to UK tax on exit, even if that asset is held outside the UK.

Accordingly, family offices need to factor in UK taxes (on acquisition, holding and exit) if looking to invest in UK hotels.

Structuring the investment/acquisition

Direct purchases

Real estate transfer tax can be a significant driver in how a hotel deal is structured.

Direct acquisitions of hotels in the UK are subject to real estate transfer tax – being stamp duty land tax (SDLT) for properties in England and Northern Ireland. Similar taxes are charged on the purchase of real estate in Scotland (Land and Building Transaction Tax, or LBTT) and Wales (Land Transaction Tax, or LTT). For convenience, this article focusses on SDLT.

SDLT is generally charged on a progressive “slice” system where different parts of the purchase price are charged at increasing rates. Acquisitions of hotels are, helpfully, subject to the lower commercial rates of SDLT. On a hotel acquisition, most of the purchase price will be subject to SDLT at a rate of 5% (bar the first £250,000 of purchase price, which is taxed at a lower rate). SDLT has to be paid within 14 days of acquisition, so investors must ensure they have sufficient funds in place to pay the tax shortly after acquisition

In contrast to SDLT rates for wholly residential property, commercial SDLT rates are the same whether the purchaser is UK or non-UK.

Indirect purchases

SDLT only applies to direct purchases of real estate. It does not apply to indirect acquisitions of UK hotel businesses and assets via share sales. As such, significant transfer tax savings can be achieved by structuring a UK hotel acquisition as a purchase of shares in an existing holding company.

Stamp duty at a flat rate of 0.5% is payable on a purchase of a UK company, which compares favourably to the 5% top rate of SDLT if purchasing a hotel directly. If the hotel is held through a non-UK company, then the transfer tax would depend on the relevant jurisdiction.

No stamp duty is charged if the investment takes the form of a subscription for new shares in the hotel owning group.

OpCo/PropCo holding structures

An “OpCo/PropCo” structure has historically been (and remains) a popular way to hold hotel assets and businesses – for UK tax and wider commercial reasons.

Under an OpCo/PropCo structure, the actual hotel property asset is separated from the trading business (assuming both are held in the same structure), with the property asset held by the PropCo. The hotel trading business is then operated through the OpCo (which could, for example, be a subsidiary or sister company of the PropCo). OpCo will receive trading income from the hotel business, and then pay a rent to PropCo (for example a rent calculated as a percentage of the hotel turnover).

Such a structure has non-tax benefits as well – in particular the ability to ringfence any risks associated with the trading business (including going insolvent or being put into administration) from the valuable property asset.

Key tax considerations

An OpCo will typically be a UK incorporated and tax resident company. As OpCo will trade through a UK fixed place of business (the hotel), it will pay UK corporation tax on its trading profits (i.e. profits from the hotel business) even if it were incorporated and tax resident outside the UK. Corporation tax is currently charged at a rate of up to 25%.

However, historically there was merit in establishing PropCo in a tax efficient jurisdiction outside the UK (Jersey being an example) as any capital growth on the hotel asset could be taken outside of the UK tax net on an exit. Rent paid by OpCo to PropCo was, however, still subject to UK tax (although until 2020, PropCo would expect to pay income rather than corporation tax if offshore).

The benefits of “offshoring” UK real estate (not just hotels, but all commercial real estate) were generally reduced following significant changes to the UK tax rules in 2019 and 2020. The basic principle now is that sales and lettings of UK real estate by non-UK corporate entities are generally subject to UK corporation tax, currently at a rate of up to 25%.

The rule changes impacted not just direct sales of UK real estate, but also indirect sales of “property rich companies” by non-residents. Property rich for this purpose is a company or group that derives at least 75% of its gross asset value from UK real estate. So, whilst a corporate wrapper sale of UK real estate may still have transfer tax benefits for a buyer (as discussed earlier, given the significant difference between stamp duty and SDLT rates), a seller might normally expect to pay UK tax on either a direct or corporate wrapper sale of UK real estate.

Trading exemption

However, notwithstanding these UK tax changes, investors in UK hotel businesses can still potentially benefit from a UK tax free exit on sale.

Broadly, a non-resident is not subject to UK tax on gains when selling a property rich company that uses the UK real estate for certain trading purposes – which includes businesses such as retailers and hotel trading businesses. Trading activities (such as that of a retailer or hotel operator) must be distinguished from property rental activities for this purpose.

This trading exemption can benefit both corporate and individual investors and can apply even if the property and hotel trading functions have been separated into different (but connected) companies, as might be the case under an OpCo/PropCo structure.

However, the trading exemption would not apply to investments in a structure which only holds the property asset and which (for example) is let to a 3rd party operator. The mere letting of property is not trading for this purpose – the exemption is only available where either the property-owning company, or a connected person such as another group company, carries on the hotel trading business.

Minority interest investors

Even if the trading exemption is not available, an international family office investor in a corporate structure is not caught by the UK property rich company rules where they only hold a minority interest, being less than 25% of the voting and economic rights in the company.

Interests held by connected persons, such as spouses and certain other relatives, are aggregated in applying the 25% test.

Summary

In summary, a non-UK based family office looking to invest in a UK hotel business held (as is often the case) in a corporate structure, or looking to establish a new holding structure, needs to consider carefully whether the trading exemption would be available on a future exit – for example is it an investment in just the property asset with a rental stream from a 3rd party operator, or is the investment in a company/group that will run the hotel trading business as well.

Profit repatriation

The UK will generally treat a company structure (whether involving UK or non-UK companies) as tax opaque, meaning that investors are not taxed directly on underlying hotel profits. Unlike some jurisdictions, the UK does not offer a mechanism whereby company structures can be elected as tax transparent (although such an election is possible for certain offshore unit trusts).

Accordingly, whilst the corporate structure will be subject to UK corporation tax on hotel trading and rental profits, non-UK based investors should not suffer any further UK tax on profit repatriations by way of dividend.

In particular, the UK does not levy withholding taxes on dividends by a UK tax resident company.

Other structures

Many of the corporation tax considerations discussed for OpCo/PropCo structures will apply to other corporate structures holding UK hotels, even if not utilising a split structure between the hotel asset and trading operation. Family offices should factor in UK corporation tax on profit and also UK taxes on exit.

Whilst a full review of all types of structures is outside the scope of this article, family offices wishing to explore alternative structures such as tax transparent partnerships (perhaps a fund structure) will need to consider the implications of being taxed directly on their share of underlying UK income and gains, particularly with regard to the widening of the UK rules taxing non-residents on UK real estate income and gains.

Conclusion

International family offices looking to invest in the UK hotel sector (typically through a corporate structure, for some of the reasons discussed in their article) should plan accordingly with the knowledge that exit gains on those investments are expected to be taxed in the UK, unless the aforementioned trading or minority exemptions apply.

However, it should also be noted that:

• SDLT rates on non-residential property (including hotels) have remained relatively stable in recent times, being unchanged since 2016.
• The current UK Government has indicated a desire to keep the top rate of corporation tax fixed at 25% for the remainder of this Parliamentary term. 

Family office investors looking to acquire and hold UK hotels in corporate structures can therefore take some confidence that radical changes to their UK tax position are not currently being planned - for now at least.

If you are a family office exploring your potential options with UK hotels or other real estate from a UK tax perspective, we would be delighted to discuss and help identify the best structure for you.