Please see Dixcart Article IN539, which details some additional changes in relation to foreign ownership of UK commercial real estate.
There have been a number of changes to the taxation of UK property in recent years. The majority of these changes have been focused on residential property and have not affected commercial property.
- Ongoing reductions in UK corporate tax, now 19% and moving to 17% in 2020, continue to make UK commercial property an attractive investment option.
The choice of holding structure used to purchase commercial property can have a significant impact on tax liabilities from purchase through to sale. This article focuses on the key tax considerations when purchasing, renting and selling commercial property in the UK.
Purchasing UK Commercial Property
Stamp Duty Land Tax (SDLT)
Stamp Duty Land Tax (“SDLT”) is applicable to the purchase of property situated in England, Wales and Northern Ireland. Land and Building Transaction Tax is applicable to property situated in Scotland (appropriate professional Scottish tax advice should be taken).
- For the purchase of commercial property over £150,000, SDLT starts at 2%. This increases (on a ‘tranche’ basis) to 5% for transactions over £250,000. The same relevant rate applies to individuals, trustees and corporate purchasers. SDLT is applicable to the VAT inclusive transaction value, where VAT is payable.
Other Considerations on Purchase
- The purchaser must establish the VAT position of the property and whether VAT will be payable on its acquisition or whether the property can be transferred as a VAT exempt ‘transfer of a going concern’ (TOGC). This will depend on whether the sellers have opted to tax for VAT purposes; this may, in part, depend on whether their tenants are able to recover VAT charged on rent. To qualify for TOGC treatment, the purchaser will need to register for VAT.
- If shares in a company owning commercial property are purchased, rather than the property itself, there will be no SDLT, but stamp duty of 0.5% will be payable on the consideration given for shares in a UK company. There are commercial and tax risks when buying a company, and inheriting its history, and full due diligence should be undertaken.
- The purchaser should review the capital allowances position, and consider making a section 198 election (see Capital Allowances below).
Renting the Property
Income from renting UK commercial property is subject to tax. Deductions are available for expenses, such as interest and letting agent fees. The tax rate applicable will depend on whether the lessor is an individual, trustee or company.
Individuals letting UK commercial property are subject to income tax at marginal tax rates of up to 45% of the net rental income, regardless of their UK residence status.
UK and non-UK resident trustees are subject to income tax at 45% on net rental income.
A UK resident company is subject to corporation tax (currently 19%, reducing to 17% in April 2020) on net rental profit. Deductions are generally available for expenses. Since April 2017, however, there has been a restriction on the amount of interest and other finance costs that a company can deduct when calculating its profit. Interest costs are restricted to 30% of ‘earnings before interest, taxes, depreciation and amortisation’, subject to a threshold of £2 million.
A non-UK resident company is subject to income tax at 20% of its net rental profit. The UK Government has indicated, however, that corporate non-resident landlords may in future be subject to UK corporation tax on their rental profit.
If the shareholders of the non-UK resident company are UK resident, or the settlor of the trust holding the property is UK resident, the underlying UK source income may be attributed to the shareholder/settlor. Additional tax of up to 45% would then be due. In these circumstances, a credit for the 20% tax paid by the non-UK resident company would be applicable.
- It is important to note that the ‘Annual Tax on Enveloped Dwellings’ and related charges are not applicable to commercial property. Companies, therefore, generally remain an appropriate acquisition vehicle for commercial properties.
- Non-UK Resident Landlords
Non-UK resident landlords, whether individuals, companies or trustees, are subject to a 20% withholding tax on rent received. This is unless an application is made to HMRC under the non-resident landlord scheme for rents to be paid gross. The 20% withholding tax does not discharge the non-resident’s tax liability but it is used as a credit against that liability, as indicated above.
The UK tax system does not allow a deduction for depreciation. Capital allowances are instead available on qualifying assets, which are allocated to a capital allowances pool. Depending on the nature of the assets, allowances of either 18% or 8% are available on a reducing balance basis.
The building itself does not qualify for allowances, but they may be available in relation to fixtures and fittings through a section 198 election as mentioned under the ‘Considerations on Purchase’ section above.
Ownership of UK Commercial Property: Inheritance Tax (IHT)
UK Inheritance Tax (“IHT”) applies to UK assets which are directly owned, regardless of the residence or domicile status of the owner.
IHT of 40% is chargeable on an individual’s assets held on death, above a tax free allowance of £325,000. It also applies to any gifts made within seven years prior to death. However, a tapering of the IHT rate is applicable to gifts.
A charge of 20% IHT is incurred on the transfer of a UK property to a trust. UK assets will be subject to a 6% IHT charge every 10 years, with a pro-rata 6% IHT charge on any distributions from the trust. In addition, if the settlor retains an interest in the trust, the property will remain in his estate for IHT purposes.
If commercial property is owned through a non-UK resident company by individuals not domiciled in the UK, nor deemed to be domiciled in the UK, the commercial property will not be included as part of their estate for IHT purposes. For IHT purposes they are treated as owning non-UK situs shares.
Since 6 April 2017, this has not been the case for UK residential property.
The Sale of Property
Whilst HMRC has not announced a consultation at the time of writing, Non-UK resident individuals, trustees and companies, are not subject to UK tax on the disposal of commercial property held for investment purposes. Specific rules apply where a property is or becomes a development property. These specific rules are outside the scope of this article and further professional advice should be taken.
UK resident individuals are subject to Capital Gains Tax (“CGT”) on gains realised on the disposal of UK commercial property. They may be taxed at either 10% or 20%. The tax rate will depend on whether the individual has any basic rate band remaining after calculating their income for income tax purposes. A consultation has been announced and this application of CGT is being reviewed and may be subject to future change.
UK resident trustees are subject to CGT at 20% on gains realised on disposal.
A UK resident company is subject to corporation tax at 19% on gains realised on the disposal of commercial property. The sale of shares in a non-UK resident company by a non-UK resident individual does not currently attract UK CGT.
In most circumstances the recommendation remains that a company should be used for the purchase of commercial property in the UK. However, HMRC recently announced their intention to consult on extending CGT and IHT to commercial property. It is therefore even more important to consider the appropriate holding structure and the taxation of the property over the life of the investment, prior to any purchase being undertaken.
Professional advice should be taken to ensure that individuals and companies have considered all of the relevant tax issues.
If you require additional information on this topic please contact your usual Dixcart adviser or speak to Paul Webb or Peter Robertson in the UK office: email@example.com.