Changes to the UK taxation of UK residential property: time to act?
- Companies holding UK residential properties are commonly subject to an annual tax charged by reference to their value, called the Annual Tax on Enveloped Dwellings (ATED). However, ATED does not apply to a company if any UK residential properties held by it are let on a commercial basis to unconnected persons.
- Up to now, many non-UK domiciled shareholders in property-owning companies have seen ATED as a price that is worth paying, because non-UK incorporated companies have worked for these individuals as an inheritance tax (IHT) “blocker”. Under current law, such a company prevents any exposure to IHT with respect to any underlying UK residential property.
- This key benefit of corporate ownership of UK residential property is about to be stripped away. From 6 April 2017, such companies will no longer function as IHT “blockers” for non-UK domiciled shareholders. The change applies to commercially let residential properties, as well as properties that are occupied by shareholders or related persons.
- In the majority of cases, there is no longer any good reason to leave a UK residential property within a company if the property is owner occupied – although the position may be different for residential properties that are commercially let. If they have not done so already, shareholders in property-owning companies should now take advice about the best way for the property to be held, going forward.
- Where such advice has already been taken, in many cases it will now be appropriate to start the process of liquidating the company.
- Once the property has been transferred into individual names, English law wills are likely to be required. The drafting of such wills should take IHT considerations into account.
Historically, it has been common for non-UK resident, non-UK domiciliaries to hold UK residential property through non-UK companies. Such structures offered protection for the individual from IHT in respect of the residential property, as the asset held by the individual was the shares in the non-UK company not the property itself. The ultimate owner’s privacy was also protected, as the property was shown at the Land Registry as being owned by the company.
However, over the past few years, the UK government has made significant changes to the taxation of companies holding UK residential property, aimed at discouraging the use of such structures. In particular, corporate owners of UK residential property have, since April 2013, typically been subject to an annual tax, ATED.
Where applicable, the ATED charge currently ranges from £3,500 to £218,200 per annum, depending on the value of the property. The ATED charge is subject to some exemptions, including one for commercially let properties which are occupied by persons unconnected with the company.
Following additional changes in 2013 and 2015, all non-resident owners of UK residential property (whether corporate or individual) are also now subject to capital gains tax (CGT) on any gains realised on disposals of UK residential properties. There is no exemption for let properties, although let properties in corporate ownership benefit from a lower rate of CGT.
When these changes were introduced, many non-UK resident individuals decided to retain their corporate holding structures as they took the view that ATED was a price worth paying for the continued advantages of IHT protection and privacy, and typically the structure was neutral where CGT was concerned. However, this is about to change.
Where we are now
Following an initial announcement in 2015, the Government has recently confirmed that it will be pressing ahead with various tax changes, including a removal of the IHT protection offered by closely held corporate structures for all UK residential property (whether or not let out), with effect from 6 April 2017.
From that date, any non-UK domiciled shareholder in a closely held non-UK company will be within the scope of IHT, if and to the extent that the value of the company derives from underlying UK residential property. IHT will be chargeable on the death of such an individual, unless his or her interest in the company passes to a spouse or civil partner. Any such IHT charge will be at 40% of the value of the individual’s shares except for, typically, the first £325,000.
There will also be scope for IHT charges if gifts of shareholdings in such companies are given to, held within or distributed out of trusts. In particular there will be scope for a 40% IHT charge on the death of a trust’s settlor, if the trust holds shares in such a company and he was a beneficiary of it.
How should you respond?
Companies within ATED
In very many cases, the right option for a company which is subject to ATED will be for the company to be liquidated and the property transferred to individual shareholders.
Before any such liquidation occurs, thought should be given to whether some/all of the shares should be transferred, e.g. from the current owner to his/her children. Generally, transfers of ownership should be effected by changes to the ownership of the company, prior to 6 April 2017 and obviously before the company is liquidated, instead of changes to ownership of the property. However, complicated UK tax issues can arise with such transfers and expert advice should be obtained.
Companies outside ATED
By contrast, a company holding a commercially let residential property which is exempt from ATED may be worth retaining – despite the loss of IHT protection from 6 April 2017. Such a company may reduce the effective rate of income tax on rental income, and of CGT in the event of a sale of the property.
Possible side effects include…
Unwinding a corporate holding structure may crystallise a latent gain on the property, giving rise to an immediate CGT liability. CGT may be due at a rate between 18% and 28%, depending on the facts. In many cases not all of the gain will be taxable, only the gain from April 2013 or April 2015 – depending on when the property was acquired and when it came within the scope of ATED.
When the IHT change was first announced in 2015, the UK government suggested that relief might be available on unwinding - for example, to enable the deferral of the gain on the property until it is sold in the future. However, it is clear from a recent government publication that there will be no such relief. Therefore, the CGT should be calculated before proceeding with a liquidation, to confirm that sufficient funds are available to pay this liability once triggered.
Care will also need to be taken with any unwinding process to ensure that it does not give rise to SDLT (stamp duty). This is a particular issue if the company has a mortgage on the property or has an unsecured debt to a person other than its shareholder(s). From this standpoint, it may be desirable for any such mortgage/debt to be eliminated, if possible, prior to the liquidation.
However, consideration should also be given to the IHT effect if debts of the company are repaid. A debt which was incurred by the company to purchase the property may be deductible for IHT. This IHT benefit cannot normally be reinstated after the liquidation.
Once the property has been transferred into the names of the shareholders, in most cases an English law will should be executed by each owner to determine how the property passes on his or her death. This provides clarity as to succession, should ensure that the legal process following the death of one of the property owners is as smooth as possible, and may have tax advantages.
Dangers of DIY
The interaction of UK tax rules in this area is intricate, and restructuring can lead to disastrous outcomes if steps are taken without specialist advice.
Charles Russell Speechlys can provide specialist UK tax advice to analyse the impact of the above tax regime for non-UK resident owners of corporate holding structures, and can then assist with implementation of any unwinding to ensure that this is done in a tax-efficient way. We can also prepare English law wills for the owners of the property.
We are experts in this area and would be delighted to assist clients to take the necessary steps, where possible before the new IHT rules take effect on 6 April 2017.
This article was written by Dominic Lawrance.
For further information, please get in touch with your usual Charles Russell Speechlys contact.