Capital gains tax: is it time to jump ship?

The net returns of most overseas investors in UK property will be negatively impacted when changes to the tax regime come into effect in April 2019. Non-UK investors will see the introduction of a new tax on gains: 19% for corporates, 20% on commercial property and 28% on residential property for non-corporates. The charge will also apply to gains from the disposal of “property-rich” entities by a person (alone or “acting together” with others) owning an interest of at least 25%. The move is designed to level the playing field for UK investors and to reduce the tax advantage of holding UK property through offshore structures. The concern is that these goals are to be achieved at the expense of a market that has enjoyed a large influx of overseas money in recent years. So what are your options to negate the impact of the new regime? Under the current proposal, there is limited ability to escape the tax charge, although some strategies may be more appealing: UK REITs may become more popular, since the tax charge may not apply within a REIT; Dilution of “property-rich” entities (where at least 75% of their value derives from UK land) may be achieved through bundling other assets in a sale; and Co-investment of less than 25% in a pooled vehicle may work if it is not a club deal, but this is not yet clear. Other workarounds appear to be well-covered: The benefits of double tax treaties providing an exemption (such as with Luxembourg on an indirect disposal) are likely to be nullified, for new structures at least, by an anti-avoidance rule aimed to prevent treaty shopping; and There is a limited exemption for tax-exempt investors, although they could still indirectly bear the cost of the tax charge being imposed on a property sale by an offshore entity through which they have directly or indirectly invested (as will be the case for most non-UK fund structures). So, will the UK remain an attractive market, or is an exodus on the horizon? Clarity is required The government seems set on introducing the proposal. However, we expect intensive lobbying against some of its aspects, including the following: There is potential for a double tax charge, because the  disposal of a property-rich entity does not result in an uplift in the tax basis of the underlying property; A clear exemption is needed from all aspects of the tax charge for tax-exempt investors, whether investing directly or indirectly through funds or other vehicles; The “acting together” concept needs to be refined, to make clear that it does not automatically catch all co-investors in pooled vehicles, which we believe cannot have been the intention but may well be the effect of the current proposals; and It should be accompanied by incentives to use UK structures to hold UK property, such as stamp duty land tax seeding relief on moving property into UK structures from offshore. Things to bear in mind The new charges will only apply to gains accruing from April 2019; The change does not affect the stamp tax saving of buying an offshore structure holding UK property. Investors must weigh the costs of setting up and maintaining such a structure against this benefit; and Further restrictions on the amount of tax relief available on non-UK investors’ financing costs against their UK rental income are scheduled to take effect from April 2020. These may have a significant additional impact on net returns from leveraged real estate investments. The verdict There’s no need to board the lifeboats yet. Net returns for overseas investors will likely be impacted, However, the change only serves to bring the UK into line with many other major countries. Given other significant factors, such as a mature legal system, good inventory and comparatively stable yields, the UK should remain an attractive market. Regardless, we would recommend that all investors review and seek advice on their current assets and holding vehicles in order to be best prepared for the changes ahead. Caspar Fox is head of European tax and Oliver s’Jacob is head of the real estate private equity practice at Reed Smith