Taxation of residential property structures: The new regime

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1 Page 1 Taxation of residential property structures: The new regime Christine Payne Smith September 2013 The Government's recent attack on the use of corporate vehicles to hold high-value residential property consists of three key measures, namely: a higher rate of stamp duty land tax on certain high-value residential properties; an annual tax on such properties; and an extension of capital gains tax to property disposals within the new regime. This note summarises and highlights some practical implications of the new regime. It also includes a checklist of factors to consider when deciding what action to take in relation to existing structures. 1. Stamp duty land tax higher rate From 21 March 2012, an interest in a single dwelling acquired for more than 2m by a non-natural person (NNP) is subject to a 15% stamp duty land tax (SDLT) charge. Note that if a property is acquired jointly and at least one of the purchasers is an NNP, the 15% charge applies to the whole transaction. Prior to 17 July 2013 there was only a limited relief from the 15% charge, this being targeted at property developers who have been in business for at least two years. However, Finance Act 2013 introduced a wider range of reliefs from 17 July 2013, similar to those which apply for the annual tax (see below for further details). Note that there is a clawback of relief if the conditions for the relief are breached within three years of the effective date of the transaction. Key definitions Dwelling: To qualify, a property must be used or suitable for use as a single dwelling (or in the process of being constructed or adapted for use as such). Land occupied or enjoyed with the dwelling as its garden or grounds is also included (as are any buildings on such land). Non-natural person (NNP): a company; a partnership with at least one corporate partner; or a collective investment scheme. Note: The definition of NNP includes both resident and non-resident entities but does not include a company that merely holds a property as a nominee or trustee (rather than as beneficial owner). 2. Annual tax on enveloped dwellings From 1 April 2013, an annual tax on enveloped dwellings (ATED) applies to an interest in a single dwelling worth over 2m and held by an NNP (as defined above). Subject to limited exceptions, the type of property caught by the charge is similar to that within the 15% SDLT rate.

2 Page Aggregation of property interests If a property includes more than one single dwelling, the ATED conditions are applied to each separate dwelling, unless the property interests are held by connected persons (as defined in s.1122 Corporation Tax Act 2010). However, if an NNP holds more than one single dwelling interest in the same property (eg the leasehold and the freehold) the separate interests are treated as one so that their total value will be relevant for the ATED charge. Similarly, if the property is jointly owned the ATED conditions are applied to the whole property (so that the charge may apply even if the NNP's share is less than 2m). All beneficial joint owners (including those who are not within the charge) are liable for the tax; however, there are provisions to ensure that a double ATED charge does not arise. 2.2 Calculating the charge The ATED charge depends on the market value of the property (as set out below) and will increase annually in line with the Consumer Prices Index. Property Value Annual Charge m - 5m 15,000 5m - 10m 35,000 10m - 20m 70,000 20m+ 140,000 For the first year of charge, the value of the property is that on 1 April 2012 (or the date of acquisition if later). This valuation is relevant for the first five-year period and subsequent valuations must be provided at five-yearly intervals (ie at 1 April 2017 and so on). Note that it will not generally be possible to re-value a property within a five-year period to take account of a decrease in value. Although the value is self-assessed by the taxpayer, a pre-return banding check service is available for properties valued at within 10% of one of the thresholds. Importantly, if a property is not within the ATED charge for an entire year, only a proportion of the charge is due (based on the number of days the property has been held by the NNP). 2.3 Reliefs In response to concerns that the new regime would adversely affect the residential property market, a number of reliefs are included with the intention of excluding NNPs holding property for genuine business purposes from the ATED charge. Where the conditions for relief do not apply for the entire year, a relevant proportion of the charge is relieved on a daily basis. Reliefs are available for the following: Property rental businesses Dwellings used in a trade and open to the public for at least 28 days each year (eg historic houses). Property development trades Property traders

3 Page 3 Property used to provide accommodation for partners and employees (who have less than a 10% share in the business). Farmhouses (where the occupant is involved in the day-to-day farming business). Other (eg for property held by a charity). However, subject to limited exceptions, relief is not available where the property is available for occupation by a nonqualifying individual (even if a market rent is paid). Key definitions Non-qualifying individual: This has a wide definition and includes: an individual who is beneficially entitled to the property; an individual ("a connected person") connected with the above; a settlor ("a relevant settlor") where the trustee of the settlement is connected with the person who is beneficially entitled to the property; and a relative of a connected person or a relevant settlor. 2.4 Returns and payment of tax The first filing date for properties within the charge at 1 April 2013 is 1 October 2013 and payment must be made by 31 October However, for subsequent years the filing and payment date is 30 April in the relevant tax year. 3. Capital gains tax charge From 6 April 2013, a capital gains tax (CGT) charge at 28% applies to NNPs (defined as for the ATED charge) in respect of gains made on property that is subject to the ATED regime. The new charge takes priority over pre-existing tax charges on gains. 3.1 Scope of the charge The charge applies to UK resident, as well as non-uk resident, NNPs. (This will be significant for UK resident NNPs that were subject previously to the lower corporation tax rate.) However, taper relief applies where the property is worth just over 2m so as to avoid a perverse incentive to sell properties worth over 2m for less than 2m. 3.2 Rebasing of property Importantly, increases in the value of property prior to 6 April 2013 are outside the new charge, although such historic gains may still be charged to tax under established anti avoidance rules. This "rebasing" of the asset applies automatically, although it is possible to make an irrevocable election to opt out. 3.3 What if a property is not within the ATED regime for the entire period? The CGT charge only applies to the extent that a property is subject to the ATED charge. Where the property is not within the ATED regime for the entire ownership period then only a proportionate part of the gain is charged to CGT. If the value of a property does not exceed the 2m threshold at the last valuation date, it seems that it will not be within the new CGT charge, even if at the date of disposal the property is worth more than 2m. However, as noted previously, gains falling outside the new CGT charge may be subject to pre-existing tax charges (ie under the corporation tax regime or as a result of the anti-avoidance rules attributing offshore company gains to UK resident shareholders, settlors or beneficiaries).

4 Page Available losses Losses made under the new regime are ring-fenced and can only be set against ATED-regime gains made in the same or a future tax year. 3.5 Reliefs The same reliefs apply as for the ATED, so the new CGT charge does not apply, for example, to companies holding property that is let on a commercial basis to non-qualifying individuals. Where the property does not qualify for relief for the whole of the relevant ownership period, only the relevant proportion of the CGT relief is available. 3.6 Joint property The 2m threshold is reduced proportionately where a joint owner disposes of his share of a property. This is to prevent avoidance of the new charge through the fragmentation of property ownership. However, in a case of joint ownership between one or more NNPs and non-nnps, only the portion of the gain attributable to the NNP is charged to CGT. 3.7 Indirect property ownership The new CGT charge does not apply to disposals of property held indirectly by NNPs (so disposals of shareholdings in companies holding ATED-regime property are not caught by the new regime). 4. Practical points The range of reliefs, together with the fact that direct trust ownership is not caught by the new regime, means that many residential property structures fall outside the scope of the new rules. Consequently, the main focus for restructuring relates to corporate structures where the property is occupied by a non-qualifying individual. The introduction of rebasing (and the fact that only a proportion of the year's ATED charge must be paid if the structure is dismantled during the year) has provided a period of grace to decide how to deal with existing structures. It will be important to monitor structures carefully to ensure, where relevant, the continued availability of reliefs (eg ensuring that a non-qualifying individual does not use the property). Valuations should be undertaken for property within the new regime as at 1 April 2012 for the ATED and as at 5 April 2013 as regards the new CGT charge. In addition, NNPs with property just under the 2m threshold need to keep the value under review. An election to opt out of rebasing under the new CGT charge must be made in the tax return in which the disposal is reported on or after 6 April Such an election may be advantageous if the property is standing at a loss at 6 April Reliefs must be claimed annually on a "nil charge return" which may give rise to an administrative burden. Unless a relief applies, the acquisition of high-value residential property through an NNP is considerably less attractive following the introduction of the new regime. Direct ownership or ownership through a trust may be the best option, with separate measures to mitigate the inheritance tax exposure (eg debt financing, provided that this does not fall foul of the new deductibility of debt rules).

5 Page 5 Checklist: What action to take? Whether existing property structures caught by the new regime should be retained, collapsed or restructured necessarily depends on the particular facts and circumstances of the individual case. However, a checklist of a number of factors that may be relevant when deciding what action to take is set out below. 1. Impact of the new charges relative to the existing benefits of the structure. 2. Does the structure have the means to fund the ATED? If not, will a contribution of funds to the structure to meet this liability have adverse tax consequences (eg tax on remittances)? 3. Loss of inheritance tax protection if the structure is collapsed (and whether this can be mitigated by insurance, debt etc). 4. Loss of confidentiality if structure is collapsed (although a nominee holding company may assist). 5. Costs of restructuring, including possible immediate CGT liability for a settlor (if UK resident and domiciled) or a beneficiary occupying property (if UK resident) taking into account any rebasing election made following Finance Act CGT/income tax liability on a transfer of the property to UK resident individuals. 7. SDLT on a transfer of the property (ie if there is outstanding debt). 8. Foreign tax and practical implications of restructuring (eg is the company able to give the property to shareholders under the law of incorporation?) 9. Relevant timeframes (eg for liquidating a company, arranging debt finance). If you require further information on anything covered in this briefing please contact Christine Payne Smith ) or your usual contact at the firm on This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances. Farrer & Co LLP, September 2013

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