UK non-resident capital gains tax - new regime for real estate funds
Plenty has been written on the basic rules and changes, but it is worth a brief recap for background.
- Until this change, with the exception of rules introduced in 2013 and 2015 for some residential property, the UK did not tax non-UK residents on capital gains at all. With effect from April 1, 2019 this changes, and non-UK residents will be subject to tax on gains on UK real estate which is directly held.
- They will also be subject to tax on gains on property-rich vehicles - vehicles which derive 75 percent or more of their value from UK real estate. Outside of a funds context, this charge will usually only apply where the person making the disposal has at least a 25 percent interest in the property-rich company.
- There is an optional rebasing as of April 1, 2019, so investors should only generally be subject to capital gains tax (CGT) on gains arising after that date (or on their actual gain, if an election is made, for example because the property is standing at a loss on that date).
There are various exemptions which are available, including in relation to properties used in trades and exemptions for foreign pension funds and certain charities and sovereign wealth funds - most of which ought not to be worse off as a result of the charge.
However, one of the main areas of uncertainty revolved around the treatment of funds and other collective investment vehicles: including, in particular, the possibility for multiple charges and significant indirect tax for UK pension funds.
The JPUT conundrum and fund problems
One of the features of the UK’s historic approach to real estate taxation has been the proliferation of Jersey property unit trusts (JPUTs) as holding vehicles for exempt investors. Jersey is the most common jurisdiction for these, hence the generic reference to JPUTs, but to be fair to other islands, they are also available and often based in Guernsey and the Isle of Man.
UK pension funds are exempt from tax, but when they make property investments they need to use a special purpose vehicle ("SPV") to facilitate borrowing from a bank, provide limited liability, and allow for joint ventures and funds with other investors.
A company would not be ideal in these circumstances, as it would be subject to tax on its UK property income (and gains - in the case of a UK company before these changes). A JPUT, however, is transparent for income tax purposes so income can flow through to exempt investors and they can claim their own exemption.
The JPUT is treated as a company for CGT (and Stamp Duty Land Tax) purposes - but until now that did not matter as there was no CGT for a non-UK resident JPUT.
The result is that a huge proportion of UK institutional and pension investment in real estate is through these vehicles, which, without more, would all have been subject to tax from April 1, 2019.
Away from simple investment in JPUTs, many other fund structures which involve multiple tiers of entities would, under the basic rules, have resulted in the potential for double tax charges and for tax charges to arise even where ultimate investors might be exempt.
HM Revenue & Customs (HMRC) engaged very readily with the industry to fix these points, to their credit. There was a concern among some of the more cynical members of the tax profession that this inadvertent tax burden for pension funds might have been left unaddressed (as has been the case in the past) to provide an extra boost to tax takings. However, the approach has instead been to protect the value of the pension funds and the attraction of the UK as a property investment jurisdiction.
The outcome is the ability to make one of two elections - a transparency election or an exemption election. In combination, and subject to some tweaks which will hopefully be addressed in future iterations of the legislation or in guidance, these elections should ensure that double taxation and indirect taxation of exempt investors can be prevented provided some care is taken. The downside, as ever, is that there is likely to be additional reporting and administrative cost to do so.
The transparency election
Any collective investment vehicle which is transparent for income tax purposes - most obviously a JPUT - can elect to be transparent for CGT purposes as well. Where this election is made, it will be as if the investor held the property directly (or, technically, in partnership with the other investors). When the property or the JPUT is sold, the investor is treated as selling the underlying property.
This means that investors who are exempt can claim their exemption, and investors who are not exempt should be subject to tax only once.
The exemption election
A fund which is widely marketed or otherwise not closely held (in certain circumstances - the rules are complicated!) can also choose to be treated as a company for UK tax purposes, but to make an election to be exempt. Where the fund is a partnership, this applies to entities owned by that partnership - but the effect should be similar.
Where this election is made, the fund vehicle itself will be tax exempt, but so will all of its subsidiary vehicles, be they companies or JPUTs (which have not elected to be transparent). Therefore, this election ensures that, however complex an investment structure is, there should not be double tax charges within the fund structure.
The quid pro quo of exemption for the fund is that the investor is subject to tax on disposals of interests in the fund itself. If the investor is exempt, then the exemption will apply to gains on interests in the fund.
However, there are reporting requirements for the fund to comply with and the investors will have to file and pay UK tax. HMRC are looking at options for the fund to be able to do this on behalf of investors, but this won’t be ready in time for April 2019, so international investors who do not want to interact with HMRC and file tax returns will be disappointed.
However, that aside, this election gives offshore funds some treatment very similar to that of a UK REIT (real estate investment trust) for CGT purposes.
While the two elections are very helpful, they do have their quirks and so most fund managers and advisers are looking at structures to work out the best combination of elections for their particular structure. There are going to be choices to make - for example, around the need for investors to file tax returns and pay tax.
Some international investors, due to the scale of their investments, and the administrative burden it would entail, are dead set against having any reporting obligations and will need new structures which can take care of reporting, and tax paying, for them.
In conclusion, HMRC have taken a very helpful approach. A change in law which could have hit many UK pension funds with a significant tax charge and made the use of non-UK investment funds very tax inefficient has been avoided.
Indeed, from fearing for the future of non-UK funds, in particular in the Channel Islands, the new regime potentially makes them more attractive than ever, with a codified exemption regime and, like a REIT, the ability to hold through opaque or transparent SPVs with no additional tax charges beyond those on the ultimate investor and with no requirement to be listed.
This article originally featured on Bloomberg Tax: https://www.bna.com/insight-uk-nonresident-n57982094952/
Reproduced with permission from Copyright 2018 The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com/