Should I keep my property business in an offshore company?

A question professional advisers are often asked is “should I put my property business through an offshore company or trust?” The perception is that offshore entities mean less tax. That is only partly true. An offshore company will often pay no tax in a low or preferential tax jurisdiction (known commonly as a “tax haven”). The UK is not alone in having “anti-avoidance legislation” which hypothetically traces the income and gains to the ultimate owner immediately. The effect is to put the UK resident individual into the tax position they would have been in had they not used an overseas structure.  The question then asked is “why do businesses still continue to use offshore jurisdictions?” Commercially, there are two main advantages. A business which operates through tax havens will not have to make the same public disclosures such as accounts and ownership that a UK company will. This allows for commercial privacy when tendering for projects. The second advantage is that foreign partners bringing overseas funding and expertise together with a UK landowner want some control to limit where they are taxed.      Some believe this confidentiality has been exploited too far with the result that, despite anti-avoidance legislation, bank accounts behind offshore businesses have been used to hide income and gains from HMRC. More than 100 countries faced with the same issues have joined forces to share information. Some tax havens have signed up to this protocol. This joining of forces is known as the Common Reporting Standard, which results in the beneficial ownership of foreign accounts that may hold rental income or development gains being revealed to HMRC from which it will make further enquiries.  Gradual changes Already, HMRC has an armoury of weapons to deal with tax avoidance. Anti-avoidance rules put into place decades ago pierce the veil of incorporation to look through any transaction where a person transfers assets to an offshore company, trust or individual registered abroad, with the aim of avoiding UK income tax. If an individual therefore sets up an offshore company to hold a rental property, any income that arises in that company could still be taxable on the individual directly at their marginal income tax rate. This could be as high as 45%. The result is that transferring assets to an offshore company when you are UK tax resident, or even before becoming resident, may have no UK tax benefits and could be worse than holding through a UK company. For capital gains tax purposes there is also a parallel provision that taxes gains made in an offshore company on a UK resident shareholder. More recently, the April 2017 extension of inheritance tax traces residential property value back to individuals. What were once solid shelters from inheritance tax, no longer are. It is not all bad news. There are some exemptions, where the entity is created for commercial reasons without UK tax being a main driver. For income tax there is the “commercial defence”. Many property investors seek to rely on this defence in the event of an HMRC investigation. This year the burden will weigh greater on UK resident taxpayers who are obliged to disclose and correct any offshore irregularities. An offshore company or trust may have been set up many years ago. Its operations, ownership, underlying property interests and funding may have evolved over time.  What was okay then may not be so defensible under current tax law and may come within this new measure. The requirement to correct So what are we talking about? The Finance Act 2017 introduced the “requirement to correct” (RTC). The new rules are designed to exhort taxpayers with offshore interests to review their UK tax affairs and to “correct” past errors and omissions, whether this is in relation to an incorrect tax return or a failure to notify chargeability. Those with undeclared UK tax liabilities relating to all periods up to 5 April 2017 should ensure matters are fully disclosed to HMRC by 30 September 2018. Those with complex offshore interests who are unsure whether their affairs are correct and up to date should ask their advisers to undertake a full review of all offshore interests and structures to ensure any irregularity is identified and disclosed by 30 September 2018. Those who fail to take the required review and disclosure action by this date will be exposed to the harsh failure to correct (FTC) penalties. The 30 September 2018 date is incorporated into the RTC legislation, coinciding with the first full automatic exchange of financial information between the 104 countries that have adopted the Common Reporting Standard. This unprecedented annual automatic exchange of financial data is undoubtedly a watershed in HMRC’s ability to access tax-sensitive data, and identify and investigate offshore non-compliance, whether deliberate or otherwise. Under RTC, the normal HMRC assessing time limits of four years are extended as at 5 April 2017 until 5 April 2021. This means liabilities relating to earlier periods will not fall outside the scope of HMRC’s normal assessing powers. The 20-year time limit applying in relation to a “deliberate understatement” of tax can be extended to 24 years. For “careless behaviour”, the six-year assessment period can be extended to 10 years. Taxpayers with offshore interests now have just over six months left to both review their affairs and make any corrections, while HMRC has until April 2021 to identify cases, investigate and raise assessments where they discover irregularities. HMRC is, of course, already looking. Failure to correct For those who fail to meet the deadline, penalties may be applied (see box, below). It can be seen that the maximum penalty is a staggering 300% with a minimum penalty of 100% of the unreported tax. The only defence to having FTC penalties imposed is to have a reasonable excuse for not having made corrections.    It should be noted that HMRC will deploy its ultimate sanction of criminal investigation, with a view to prosecution, where they consider that the irregularities, either disclosed by the taxpayer or discovered by HMRC, are deliberate or, worse, deliberate and concealed, as an alternative sanction to the FTC penalties. Conclusion Holding real estate interests in a foreign entity will lead to greater scrutiny. This does not mean foreign holding entities are unsuitable, for the reason explained at the beginning. However, the government is clearly trying to persuade those looking to invest particularly in UK property to do so either in their personal capacity or through a UK corporate. The benefits are a lower corporation tax rate of 17% from 2020 and we may see an even lower rate in the future. In addition, the anti-avoidance rules fall away and shareholders can manage their personal tax liabilities. Compared to offshore properties, retained profits in the UK company are not taxed on shareholders directly, resulting in greater working capital to pay down bank debt or reinvest. Penalties incurred following a failure to meet the deadline: A tax-geared penalty of up to 200% of the undisclosed tax. Penalties will be reduced to a minimum of 100% only if taxpayers cooperate with HMRC. An asset-based penalty of up to 10% of its value held offshore. This would apply in the most serious cases involving additional tax of £25,000 or greater in any single tax year. HMRC reserve the right to publicly name and shame in cases where the tax on which the FTC penalty is applied exceeds £25,000. An enhanced penalty of 50% of the amount of the standard penalty, if HMRC show that assets or funds had been moved to avoid the requirement to correct. Frank Nash is the head of the property group and Gary Gardner is a tax partner specialising in tax risk and dispute resolution at Blick Rothenberg