The issue of obtaining tax relief for borrowings taken out to acquire interests in property holding structures has been a subject of discussion for many years, but recent case decisions have potentially added further complexity.
The Bluecrest case has rumbled on for many years and covers a wide range of tax aspects.
One aspect pertinent to property structures was the denial of interest costs for borrowings of a non-UK resident company against the ongoing profits of its partnership. In a nutshell, this was on the basis that the interest costs were not a partnership expense and hence not attributable to the borrower’s UK activities.
The Bluecrest decision follows on from another landmark case involving the (non) deductibility of expenses incurred by partners outside of a partnership. In the Vaines case, the partner in question was denied a deduction for the costs of a legal settlement which was not a partnership expense, and HMRC has updated its manuals to reflect its stance in the light of the decision. Read more on the Vaines case. Therefore, in the context of the Vaines decision, the result in Bluecrest is perhaps not surprising.
These cases make it clear that HMRC is continuing to pay close attention where costs are incurred by partners directly rather than by the partnership in which they are a partner and, where they are, there will likely be problems with their deductibility. As HMRC clarifies in its manuals (at PM163360), in order to benefit from a tax deduction, it is critical that any costs incurred at the partner level should be recorded in the partnership tax computation.
What about Unit Trusts?
The position in relation to Unit Trusts is more complex.
It is commonplace for properties held through unit trusts to be ‘acquired’ by acquisition of the units in the trust, with a purchaser SPV borrowing to fund the acquisition of the units. The unit holder is then taxed on the income arising to the unit trust (assuming it is a Baker Trust), with a deduction typically claimed in the computation of the unit holder for the interest incurred on the loan to acquire the units. Various views have been taken on this approach over the years, but the position has been put back into focus as a result of the Bluecrest decision.
The borrowing to acquire the units isn’t one incurred by the trustees for the unit trust to acquire the property. As a buyer, it would be possible to avoid the situation by borrowing to acquire the property from the JPUT instead of the units in the JPUT. In that circumstance, it would be very obvious that the borrowing is to acquire the property. However, this would result in SDLT becoming payable upon acquisition. The fact that acquiring the units doesn’t trigger SDLT could suggest that it isn’t an acquisition of land (as compared with the acquisition of an interest in a partnership which would likely attract SDLT if it were a property investment partnership.)
The other practical difficulty that unit trusts present is that there is no obvious opportunity to include interest incurred by unit holders as an adjustment to the unit trust accounts in the tax computation of the unit trust, as there likely won’t be one. It follows that this approach is only really viable in the case of a partnership unless a unit trust, having registered as a reporting fund, is providing annual statements of the share of profit attributable to each unitholder.
Impact of transition to corporation tax
From 6 April 2020, corporate non-resident landlords are within the scope of corporation tax and not income tax. This would include corporate partners holding interests in partnerships and corporate unit holders investing in unit trusts.
The view could be taken that interest on borrowings might fall to be treated as non-trade loan relationship deficits of the corporate partner/unit holder and thus offset against UK property rental business profits arising through holding an interest in a partnership/unit trust. However, in the light of the Bluecrest decision, this is most likely incorrect as the company will only be within the charge to corporation tax in respect of its UK property rental business and, as noted above, there is uncertainty as regards whether the interest costs fall to be part of this.
A similar scenario could arise with capital allowances. Historically, where a partnership interest is acquired, the default position would be that this does not amount to a sale/acquisition for capital allowances purposes, with capital allowances being claimed at the partnership level.
In contrast, the transfer of units in a unit trust has, in practice, historically been treated as a transfer of an interest in the underlying property for capital allowances purposes. However, the capital expenditure on the property itself would be incurred by the trustees rather than by the unit holders, so applying the Bluecrest analysis could mean that the expense derived from capital allowances is an expense of the unit trust rather than of the unit holder. This could mean that a transfer of units in a unit trust would be treated for capital allowances purposes in the same way as the transfer of an interest in a partnership, thereby denying any opportunity to benefit from claiming capital allowances to which the vendor was not entitled (such as pre-2008 integral features).
Conclusions and next steps
This is, and has been for some time, a complex area. It is critical that advice is sought early on when acquisitions are considered and when tax returns are filed. We anticipate that HMRC will continue to pay close attention to the tax returns of partners holding property-owning partnerships and, in due course, will likely turn its attention to other structures.
For further information, or for assistance, on this or any other real estate matter, please contact Andrew Crossman or Steven Dowers.