Need to know: how seismic tax changes will hit offshore vehicles

COMMENT: In a move that was reported to have “sent a chill through the investor community”, the government announced in last year’s Budget a consultation on the taxation of UK property owned by non-residents with an intent to introduce changes in April 2019, says Nicola Westbrooke, tax partner for real estate, hospitality and construction, EY. The government can expect modest additional revenues for the Red Book as a result of the changes, but with less than six months to go, it’s time for investors and fund managers to take a closer look at the changes and prepare for their implications. So far, draft legislation has been published in the Finance Bill 2018/19 but it is missing the special provisions for Offshore Collective Investment Vehicles (CIVs) that are likely to be published around the time of the Autumn Budget. What are the key features of the upcoming changes? Putting CIVs aside for the moment, the key features of the basic rules can be summarised as follows: Where non-residents come within the UK capital gains net for the first time in April 2019, there will be a “rebasing” of tax basis to market value which will effectively mean that only future value increases fall to be charged to UK tax. The regime will affect direct disposals of UK land by non-residents but also disposals of 25% plus interests in corporate vehicles in which the value of UK properties owned is at least 75% of gross assets that are deemed “UK property-rich”.  The sale of any stakes where at least 25% was owned in the past two years is also included. In this case, the tax base cost of the shares will be treated as rebased at April 2019. The rebasing can be ignored by election if historic cost would produce a better result for the taxpayer. The rate of tax payable will be the rate for the equivalent UK investor, so a non-resident company will be subject to the UK corporation tax rate on gains (currently 19%). Non-resident taxpayers will be required to file a return and pay tax within one month of disposal. There is an exemption for properties that are used to all but an “insignificant” degree for the purpose of a trade. For example, hotel or retail businesses. There are anti-avoidance provisions to both prevent “treaty shopping” after 22 November 2017 and to prevent transactions that are designed to take advantage of the new rules where the arrangement was entered into after 5 July 2018. There will no doubt be requests to HMRC to produce a white list of the types of transactions that would not fall foul of the anti-avoidance. Offshore CIVs The government is giving special consideration to CIVs because of the potential for double layers of tax at both the fund and investor level. Because of the complexities, the draft legislation is not yet published but we do know some details of its intention from the summary of responses to the consultation. So what do we know? Firstly, an offshore CIV as affected by the special rules needs to be defined. It is likely the government will pick an existing definition, perhaps a fund qualifying as a Collective Investment Scheme or an Alternative Investment Fund. For those funds qualifying as a CIV, the proposal is that the fund would default to being opaque for gains and that on an indirect disposal any level of investment will be subject to tax, not just those above 25%. As a quid pro quo for these downsides, two elections are proposed, although neither of them will be available where the CIV is not “UK property-rich”. (i) The transparency election A fund that would otherwise be tax transparent for income purposes, such as a Channel Islands “Baker” unit trust, would be able to elect for tax transparency for gains. It would then be the investors rather than the fund who would be taxable on either a disposal of the underlying property or on transfer of fund units. This does mean that it would be the investors who would have the reporting requirement for the tax (unless HMRC allow this to be done by the fund manager) and that taxable investors may suffer a tax charge before receiving distributions from the fund. If these downsides can be managed, the election is clearly an option to consider for funds with exempt investors. (ii) The exemption election The effect of this election would be to exempt the fund from tax on a disposal of UK property by the fund, and instead defer the charge until the investors receive value from the fund through a sale of units or distribution. The further conditions are likely to include additional reporting requirements and a need to meet some form of wide ownership test. No doubt these are the most seismic changes to the UK property tax landscape in a long time. Fund managers are spending time running over their existing structures to check whether they are fit for purpose – and that work stream will need to pick up pace once the draft legislation on CIVs is available for review. At a moment in time where the UK wants to attract more international capital, the impact of these changes will be watched closely by the property industry.