IN430 - What are the Major Factors Non-UK Residents Should Consider When Investing in UK Commercial Property?

Background

Whilst there have been several recent taxation changes relating to UK based residential property (explained in Dixcart Article IN396) the taxation regime for UK based commercial property remains largely untouched.

This, combined with the reducing UK corporation tax rate to 17% by 2020, mean that the UK commercial property market continues to be an interesting investment for current and new investors.

Naturally, the tax aspects of an ownership structure are an important consideration. In addition, the nature of ownership needs to be carefully considered.

Property Ownership

UK property can be owned by a corporate entity or individual(s).  

There are also two forms of ownership. Purchasers need to understand the type of interest that they are acquiring in the land and other related ongoing considerations.

  • Freehold

The owner of the freehold title to the land enjoys ownership of that land in perpetuity and can use the land as it/he wishes, subject to any local regulations or other registered restrictions.

  • Leasehold

A leaseholder enjoys the use of the land held by them for the term prescribed by the lease and prevailing law. The terms of a lease can be restrictive and potentially costly if not fully understood. Such terms may reduce options for use, impose service charges and rent increases and might bring the term of the lease to an end sooner than expected. 

  • An individual acquiring an interest in commercial property must understand the interest they are acquiring and ensure it is what they are anticipating.

Tax Considerations

This note considers the ownership of UK commercial property by non-UK residents. However, Dixcart provides a full range of professional assistance to all purchasers.

When non-residents of the UK invest in UK property, the manner in which they structure their investment can have an enormous impact on eventual returns.

Taxes that need to be considered are:

  • Stamp duty
  • Capital gains tax
  • VAT
  • Income tax
  • Inheritance tax

The effect of these taxes is most clearly demonstrated with a case study. The case study considers commercial property. It is NOT relevant to residential property for which Dixcart can provide separate advice.

Clients should always take specific tax advice prior to acquiring UK property. 

Case Study

Mr. Jones was born in South Africa, but lives in Hong Kong. Having seen the rise in the value of property in the UK, he decided to acquire a small office block in the Thames Valley corridor for £1 million.

Whilst he had a significant portfolio of shares which he did not wish to sell, he only had £300,000 cash to put towards the purchase price. He therefore borrowed £700,000 in Hong Kong, using his share portfolio as security. He then subscribed for £1 million share capital in a UK company called Big Mistake Limited.

Big Mistake Limited then purchased the freehold property for £1 million.

The property was let and in the year to 5th April, which was the first complete year of ownership, a rental income of £80,000 was received. The property was then sold for £1,200,000 to another non-UK resident.

The following are the consequences of Mr. Jones’ actions:

  • Stamp Duty

On the purchase of the property, Mr. Jones will have paid stamp duty land tax (the bands are based on the value of the property: 0% up to £150,000, 2% for the next £100,000 and 5% above £250,000). Mr. Jones had to therefore pay a total of £39,500. When he sold the building, the buyer would have to pay stamp duty land tax of £49,500.

Mr. Jones suggested to the buyer, who was also non-resident and not domiciled in the UK, that he should buy the UK company and would therefore only pay 0.5% stamp duty on the purchase of the shares of the company, i.e. £6,000. He suggested that they could make an adjustment to the price so that the benefit of this saving was shared equally.

The buyer was initially keen, but after taking advice was advised not to consider this because of potential capital gains tax liabilities.

  • Capital Gains Tax

On the sale of the property, the UK company would have to pay tax on the capital gain. The rate at which this would be paid is currently 20% as the company would pay the prevailing UK corporation tax rate (expected to fall to 17% in future years).

The amount of tax payable on the capital gain would therefore currently be 20% of £200,000, i.e. £40,000.

Had the property been purchased through an offshore company, there would have been no tax liability in respect of the capital gain on the sale of property. This is because the UK does not charge capital gains tax on non-UK resident persons or companies who have invested in commercial property.

Please note that the above is no longer the case for UK residential property.

  • VAT

When the company acquired the property, Mr. Jones was surprised that Big Mistake Limited was charged VAT at 20% on the total purchase price. Mr. Jones therefore needed to borrow a further £200,000. Whilst the company subsequently registered for VAT and was able to claim the VAT back, this took a few months to sort out and he suffered additional interest on the monies he had to borrow to pay the VAT.

If he had registered for VAT in good time, he could have ensured that he had a VAT quarter end that ended immediately after the acquisition of the property, thereby reducing the length of the loan.

Alternatively, it might have been possible, if the property was sold with an existing tenant, for the sale to be treated for VAT purposes as a transfer of a going concern, thereby avoiding the need to pay the VAT and then reclaim it.

It should be noted that, as a result of registering for VAT, Mr Jones needed to charge his tenants VAT. Fortunately this did not cause a problem, as the tenant was VAT registered and was able to reclaim any VAT charged. If the tenant had not been registered for VAT, the tenant could not have reclaimed the VAT and might therefore have been unhappy with the increase in rent payable.

  • Income Tax

Big Mistake Limited had to pay 20% corporation tax on its rental income (£80,000 x 20%), i.e. £16,000. This could have been reduced if the company had borrowed the funds for the purchase of the property, rather than Mr. Jones personally, as interest could have been offset against the income.       

It is worth noting that if the property was owned through an offshore company, rather than a UK resident company, the tax rate would be the same, at 20%, as the non-resident landlord corporate tax rate.

Assuming an offshore company had been used to acquire the property and it had borrowed the £700,000 necessary to purchase the property at an interest rate of 3%, the tax charge on the rental income would have been £11,800 instead of £16,000.

Summary

By not taking advice, Mr. Jones was faced with the following:-

 

Actual Liability

What the Liability could have been reduced to

Saving for Mr. Jones

 

£

£

£

 

 

 

 

Capital gains

40,000

Nil

40,000

 

 

 

 

Income tax

16,000

11,800

4,200

On seeing that bad planning had cost him £44,200, Mr. Jones had a heart attack and died.

Sadly, that was not the end of the poorly managed tax position.

  • Inheritance Tax

Mr. Jones left his entire estate to his daughter. The value of the UK company at the date of his death, taking into account sale proceeds and rent received (less all taxes), was £1,220,400.

Assuming Mr. Jones had no other UK assets, there would be an inheritance tax charge of £358,160, leaving £862,240 in Mr Jones’ UK estate, which would go towards the repayment of his £700,000 personal loan in Hong Kong, with the remainder available for distribution to his daughter.

If the property had been owned through an offshore company, this liability could have been reduced to nil, as Mr. Jones would have left shares in an offshore company, rather than shares in a UK company. More detailed information regarding UK inheritance tax for non-UK resident individuals can be found in Dixcart Article IN349.

Through lack of planning and by using a UK company rather than an offshore company, Mr Jones’ daughter received a total of £402,360 (£44,200 + £358,160) less than she could have received.

Additional Considerations

When using an offshore company to hold UK property, care must be taken to ensure that the company is managed and controlled outside the UK.

Whilst this case study cannot take into account all of the matters that require consideration, it demonstrates the importance of taking proper tax advice prior to investing in UK commercial property.

This note was prepared using taxation rates for the year ending 5 April 2016.

Conclusion

Dixcart can provide a full range of professional advisory services in relation to the acquisition and ownership of UK commercial property to help ensure that it is held in the most tax efficient manner possible.

If you would like further information on this topic, please contact the Dixcart office in the UK: advice.uk@dixcart.com

 

Categories: Jurisdiction, United Kingdom, Year, 2016