Are you affected by Non-resident property collective investment vehicle (CIV) tax reforms?
Overseas property owners and funds could soon pay more UK tax, as a result of new rules designed to ‘level the playing field’ between UK and overseas investors. From April 2019, non-resident property investors may become liable for capital gains tax.
The changes to UK property taxes significantly alter the tax landscape for both offshore and UK property funds and structures. They extend the charge to UK tax on capital gains. Some unexpected changes have also been introduced that extend beyond offshore structures.
Do you think your UK property investments may be affected by the tax changes?
You can use our quick and simple UK property tax tool to get a free tailored report that explains the possible impact of the tax changes and how they can be managed.
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The objectives of Non-Resident Capital Gains Tax
The original aim of the changes was to bring capital gains realised by non-UK residents from disposals of both direct and indirect interests in UK commercial investment property within the UK tax net.
The legislation implementing these changes confirms the basic position:
- Capital gains accruing from 6 April 2019 on any UK property interest - commercial or residential - held by a non-UK resident will become chargeable to UK tax (an “NRCGT” tax charge);
- The charge applies to both direct and indirect disposals so both property disposals and disposals of shares or units in property rich entities; and
- A re-basing to market value in April 2019 is available, with an option to use historic cost if this provides a better outcome which it will in most circumstances
The implementation of Non-Resident Capital Gains Tax
Following consultation, a number of relaxations have been introduced to prevent ‘funds’ and other exempt investors from suffering potential multiple layers of tax.
These relaxations have resulted in significant exemptions for ‘Collective Investment Vehicles’ (“CIVs”). CIVs will now benefit from a similar tax exemption regime for capital gains as UK REITs. Importantly, the relaxations also have application beyond offshore structures and could lead to a re-think of how real estate funds and private equity investments are structured for UK and non-UK resident property owners alike.
As well as providing an exemption from tax on capital gains for certain CIVs (“the CIV exemption”), a number of other less widely applicable amendments have been introduced. These extend the charge to capital gains tax in certain circumstances and clarify the capital gains status of certain non-company CIVs.
What are the changes to Collective Investment Vehicles capital gains taxation?
What is a Collective Investment Vehicle?
The detailed tax definition of a CIV is complex. However, in broad terms any collective or joint investment in real estate is likely to be capable of being a CIV. Specifically included within the definition of a CIV are UK REITs.
Clearly, it is important to note that the existence of a CIV is necessary in order to fall within the CIV tax provisions. The detailed CIV rules that follow will generally not be applicable to privately held or family owned property owning structures.
There will be an exemption from the charge for disposals of certain property-rich trading companies such as hotels, care homes and retailers, and disposals of property-rich entities which are ‘linked’ with a wider disposal of non-UK property rich assets.
Extension of Non-Resident CGT to minority shareholders in a CIV
The general position is that only non-resident shareholders who own 25% or more of a UK property-rich company will be subject to NRCGT from April 2019. The stated rationale for this threshold is that investors with less than 25% may not know whether the company is property-rich.
However, where such a shareholder owns shares in a CIV, they will almost always be taxable on a disposal of their shares in that entity regardless of their percentage interest.
Entity Classification Clarifications
The CIV rules deem that certain entities which are neither companies nor partnerships, will be treated as companies for the purposes of UK tax. An important example of these entities are property unit trusts, These provisions could cause multiple layers of tax to be suffered within a structure.
Provisions have been introduced to enable entities that are already transparent in respect of income, in particular property unit trusts, to elect for transparency for the purposes of the NRCGT rules. The election treats such entities as partnerships for the purposes of NRCGT, potentially avoiding NRCGT charges arising at both investor and entity levels. However, care should be taken with this election as it will generally only be appropriate where trading of the investors interests in the entity is not anticipated.
CIV Exemption Election
As noted above, the most widely applicable change introduced in the CIV NRCGT rules is the exemption regime for CIVs.
This election provides exemption from tax on gains arising to entities within a CIV structure. This exemption extends to non-UK and UK resident entities in which the fund has an interest of at least 40%.
The benefit of the exemption election is that it prevents multiple layers of tax within a structure which would otherwise be borne by all investors, regardless of whether they are exempt. It enables gains to be ‘rolled up’ tax free.
Helpfully, any inherent property gains are generally exempted on a sale of a company owned by a CIV. Importantly, this exemption applies whether the gains arise to UK resident or non-UK resident entities.
The quid pro quo of the exemption election is that gains will be charged at the level of the investors when gains are extracted from a CIV structure, unless the investor falls within certain categories of institutional investors (for example, pension and sovereign wealth funds). This brings reporting requirements for the fund and its investors.
It will impact investors who may need to register for UK tax for the first time and make payments on account of tax due. Also, as noted above, all investors in a CIV are brought within the scope of UK tax on gains, irrespective of the size of their holding.
Selecting elections and exemptions
Existing structures will need to consider very carefully the pros and cons of the new elections, exemptions and reporting requirements, taking into account the tax profile of their investors and their expected exit from an investment. In certain situations multiple elections may be possible within a fund or by certain entities.
It may be appropriate to restructure funds or consider alternative structures. Affected funds should start considering these issues as soon as possible as any restructuring will take time to implement due to the complex tax, legal and regulatory issues.
Non-UK resident pension funds and similar entities whose UK equivalent would be exempt from UK tax may qualify for exemption from the new UK tax on gains. Such investors should explore this as soon as possible.
Can all CIVs make exemption elections?
It is important to note that not all CIVs will be able to make an exemption election. Two key structures that will allow for the election to be made are:
1. Limited partnership structures, including UK limited partnerships, can benefit from the exemption election where they are widely held or meet other conditions, regardless of whether they have UK or non-UK investors.
2. Non-UK REIT equivalent companies will be able to elect for exemption. Broadly, these are non-UK tax resident companies that meet the following conditions:
- widely held
- at least half of their income is property income from long term investments
- distribute annually all, or substantially all, of its property income
- is not liable to tax on that income under the law of the territory in which it is resident.
Such companies will therefore enjoy many of the benefits of being a UK REIT in relation to tax on gains, but with lighter regulation. For example, they may not need to be admitted to trading on a recognised stock exchange. Furthermore, there is nothing to stop the non-UK tax resident REIT equivalent from holding its underlying property interests through UK resident companies.
Existing income transparent collective investment funds, such as those headed by JPUTs with corporate SPVs, will also be able to elect for exemption, subject to similar conditions.
The new CIV provisions are extremely complex and will have an impact on virtually all UK real estate investment structures with some degree of common or joint ownership. There is welcome relief in the form of the new elections for gains transparency and exemption that will benefit some situations, including some widely held wholly UK structures.
These changes also come at a time when further reforms restricting the tax deductibility of interest and use of tax losses are starting to create yet more complexity for the real estate industry.
If you have investment in UK property, we advise you to make a careful assessment of the impact of this new legislation. You can start by getting a free, tailored report and recommendations by using our Property Tax Tool.
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