In the last 2-3 years there have been a number of changes to the UK tax rules applying to the purchase of UK properties. The changing tax rules and how they interact gives rise to options and solutions to suit the client and his particular circumstances and requirements. One size does not fit all, and clients should be assisted as far as possible to make the right decisions.
A number of these changes include:
Stamp Duty Land Tax (SDLT)
In summary the recent changes to the tax rules include
- A higher rate of SDLT for corporate entities (since 26 March 2012)
- Revised rates from 0%-12% on “sliced” values up to £1,500,000 (since 4th December 2014)
- 3% surcharge for second properties over £40,000 (since 1 April 2016)
The 3% surcharge in particular is likely to prove costly for properties with higher price tags and is difficult to avoid, as “second homes” includes all properties owned outside the UK, and includes properties owned by spouses, and those owned by companies and trusts in certain circumstances. Planning to avoid the surcharge may include registering the property in the name of a family member who does not own a second property perhaps combined with a declaration of trust and other loan arrangements to prevent the outright disposal of that property by that person. The purchase might also be acquired by a life interest trust the life tenant or life tenants being beneficiaries who do not own a second property.
Annual Tax on Enveloped Dwellings (ATED)
As from 1 April 2013, UK residential properties over £2m in value held by a ‘non natural person’ i.e. a company/ body corporate or a partnership involving corporate entities and collective investment were subject to an annual tax on enveloped dwellings (ATED). From 1st April 2015, this was extended to UK residential properties over £1m in value held in the same way, and from 1st April 2016, this extended further to those over £500,000 in value.
ATED applies to both onshore and offshore corporate entities.
Any person having a “chargeable interest” which is a “single dwelling interest” interest is subject to ATED.
The “taxable value” on which ATED is based is the market value as at the date of acquisition or disposal.
A “chargeable period” starts on 1 April and ends on 31 March of the following year.
ATED is applied within number of bands. For example, properties valued between £2million and £5million, the annual tax is £23,350.
The ATED regime (combined with the higher rate of SDLT) is a disincentive to use companies to acquire residential properties (but not buy-to-lets which fall outside the scope of ATED). Companies acting as nominees are also not subject to ATED. Clients having residential properties in companies will be looking to “de-envelope” and transfer the property out of the company, or restructure the company to avoid ATED.
In the Autumn of 2015, the Chancellor of the Exchequer announced some changes to the taxation of “buy-to-lets”, which are to become effective as from 6th April 2017. There are two material changes:
- First, the amount of tax relief one can claim on mortgage interest will be capped at the basic rate of 20%.
- Second, one will no longer be able to deduct mortgage interest from rental income before one calculates ones taxable profit.
Currently one can claim tax relief at one’s marginal rate. Therefore, higher rate taxpayers will see their tax relief halved.
These changes do not apply to companies. Therefore consideration should be given to acquiring buy- to- lets in companies (but beware of the higher rate of SDLT!)
Estate and Tax Planning
As with all property acquisitions, particularly in the light of the ever increasing values of properties, and the fact that the “nil rate band” (the first £325,000 of a deceased’s estate taxed at 0%) has remained frozen for many years, a family with a modest home faces the threat of inheritance tax at 40% upon death.
This has to some extent been countered by the introduction of a “main residence nil rate band”.
It will be an extra relief available where the value of the estate is above the IHT threshold and contains a main residence which is being passed on to ‘lineal descendants’. The existing nil rate band will be unaffected and will remain fixed at £325,000 until 2020/21 inclusive.
The relief will be introduced in April 2017, for deaths on or after that date, and it will be phased in starting at £100,000 in 2017/18 and rising to £175,000 by 2020/21. For a couple, the £175,000 plus the existing £325,000 for each spouse is equivalent to £1 million. The relief will be tapered away for estates with a net value over £2m, at the rate of £1 for every £2 over that limit.
The relief will be available where a person has sold a main residence in order to downsize or to realise a capital sum, for example to pay of care home fees.
Despite this additional relief, those acquiring or restructuring property holdings ought to look into their wills and estate and tax planning using wills and declarations of trust, including:
- Structuring wills so that “spousal reliefs” (exemption from IHT on assets passing between spouses and “transferable nil rate band” so that the surviving spouse has 2 nil rate bands -£650,000)
- Declarations of trust – to split the property ownership jointly between spouses and children or other family members so that IHT burden falls on each subject to his/her nil rate band
- On buy- to- lets (not subject to “principal private residence relief”) – sharing the burden of future capital gains and annual exemption (currently £11,100) amongst individuals and to secure the lower rate of 18%, as opposed to the higher rate of 28%.
- Insurance policies “written in trust” (proceeds exempt from IHT) to provide liquidity upon death to pay IHT (and settle the mortgage) and avoid the property having to be sold to pay the tax.
The International Dimension
Non- domiciled persons who are resident in the UK would mostly buy UK residential properties in their own names, and broadly the same planning options and decisions as for UK domiciled persons would apply to UK domiciled. The inheritance tax (and other tax rules) relating to “domicile” are from 6th April 2017 subject to a “15 out of the last 20 year” rule in terms of which persons resident in the UK for 15 out of the last 20 years will be “deemed domiciled”, and will broadly be treated the same as UK domiciled persons.
One of the recent changes to the UK tax rules is the introduction of the non-resident capital gains tax as from 6th April 2015 on foreign persons or entities owning UK properties, so that any gain made post 6th April 2015 is subject to capital gains tax. For non-resident individuals, the gain may is taxed at 18% for basic rate taxpayers and 28% for higher rate taxpayers. For non-resident companies the rate is the corporate rate of 20%, and for foreign trusts the rate is 28%.
Following the announcement of changes to the taxation of non-domiciles and initial consultation in that regard in 2015, after a lengthy delay HMRC has finally published a further consultation on its policies and reforms in relation to the taxation of non-domiciled persons on 19 August 2016. The further consultation will run for two months and will close on 20 October 2016.
As part of the new regime which will become effective as from 6th April 2017 as previously announced in 2015, HMRC are to bring residential properties within the charge to IHT where they are held within an overseas corporate entity or partnerships.
Shares in offshore ‘close’ companies will no longer be excluded from IHT where all or part of their value is derived from the ownership of UK residential property.
These provisions will extend to settlors and trustees of offshore structures where the shares are owned by a trust.
The chargeable events in respect of the new rules will encompass the death of the shareholder of the offshore company, restructures of the share capital of the company by way of gifts, and inheritance tax charges coinciding with the 10th anniversary of a trust which holds the shares. The tax charges may be subject to anti-avoidance provisions, and are seemingly intended also to extend to the directors of companies owning such UK properties.
The definition of ‘residential property’ is expected to be based on that used for the purposes of non-residents capital gains tax, so that main homes are within the charge. If a property has been a dwelling within the past two years, it will be within the charge to IHT.
It is expected that relevant debts such as mortgages charged against the property may be deducted in assessing the charge to IHT in the usual manner.
A number of non-domiciled persons may already have acquired UK properties through offshore trust and company structures, so that their property structures may require advice, including:
- to “de-envelope” or restructure companies owning residential property to avoid ATED
- planning to mitigate capital gains and “ATED related gains” on future disposals of property
- restructure to mitigate IHT and/or related financial planning to ensure sufficient funding and resources to pay the IHT
Certain high net worth clients buying high value residential property may require specialised offshore planning to factor the changes into the planning for themselves and their families. Those foreigners acquiring buy-to-lets or other rental properties, even of lesser values, may require offshore structuring tailored to suit the nature of the letting ventures or commercial aspects.
The recent changes in the tax rules relating to property make it imperative that clients take appropriate advice.
Foreigners not acquiring properties through specialised offshore planning will broadly be subject to the same options and planning using the same tools as a local person. However, many of the rules familiar to long-term residents of the UK, may be alien to those who have recently arrived in the UK.
The structuring of property purchases by non-domiciled persons should dovetail with related IHT planning for non-property investments held by offshore trusts (“excluded property settlements”) before they become deemed domiciled in the UK (resident for 15 out of 20 years), many of the rules in respect of which are also presently undergoing reform (as per the consultation referred to above and effective as from 6th April 2017).
“One size does not fit all” in structuring the purchase of a property. The blind purchase of a property without any prior knowledge or consideration of the range of solutions and options pertinent to such an important transaction could lead to eventual “buyer’s remorse”, particularly if the potential tax costs, perhaps to be borne by a surviving spouse and/or future generations, might be mitigated or avoided by alternative structuring at the outset.